Trust and the Distribution of Caution

Trust is often considered a determinant of economic performance. The exogeneity of trust, however, is questionable. We develop a model with heterogeneous agents to determine aggregate trustworthiness, trust, and output. People differ according to their risk aversion (caution). The distribution of risk aversion across individuals -- along with the threat of punishment -- is critical in the process by which trust is formed. The mean and variance of the distribution of caution have direct and indirect effects on trust. For the mean, the direct effect of caution is intuitive: societies with more cautious populations would have less trust. The indirect effect, however works through the perception of trustworthiness and leads to more trust. The net effect is, paradoxically, positive in homogenous societies. In heterogeneous societies, the reverse is true. Trust and output are endogenous, and not monotonically related across countries with different moments of the distribution of caution.