Endogenous Trust and the Distribution of Caution

Trust is an important component of social capital that has been linked to improvements in macroeconomic performance. The exogeneity of trust, however, is questionable. We develop a theoretical model in which trust is endogenous and depends on three factors: institutions for capture and punishment of dishonest behavior, the share of intrinsically trustworthy people, and the distribution of risk aversion or caution across individuals. We show how the mean and variance of the distribution of caution have direct and indirect effects on trust. The indirect effects work through the perception of trustworthiness to influence trust. The indirect effects may dominate the direct effects so that more caution may counterintuitively lead to greater trust. For more homogenous societies, we find that greater caution increases trust; for more heterogeneous societies, trust declines as caution increases. We also draw out the effects of caution on trustworthiness and output per capita. Finally, we show that institutions have the expected effect on trustworthiness, trust, and output per capita