Department of Economics pres.
Economic Theory: Community Enforcement of Trust with Bounded Memory
Caroline Thomas, University of Texas
We examine how trust is sustained in large societies with random matching, when records of past transgressions are retained for a ﬁnite length of time. To incentivise trustworthiness, defaulters should be punished by temporary exclusion. However, it is proﬁtable to trust defaulters who are on the verge of rehabilitation. With perfect bounded information, defaulter exclusion unravels and trust cannot be sustained, in any puriﬁable equilibrium. A coarse information structure, that pools recent defaulters with those nearing rehabilitation, endogenously generates adverse selection, sustaining punishments. Equilibria where defaulters are trusted with positive probability improve eﬃciency, by raising the proportion of likely re-oﬀenders in the pool of defaulters.
Joint with V. Bhaskar
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