Trust and Social Collateral
This paper builds a theory of informal contract enforcement in social networks. In our model, relationships between individuals generate social collateral that can be used to control moral hazard when agents interact in a borrowing relationship. We define trust between two agents as the maximum amount that one can borrow from the other, and derive a simple reduced form expression for trust as a function of the social network. We show that trust is higher in more connected and more homogenous societies, and relate our trust measure to commonly used network statistics. Our model predicts that dense networks generate greater welfare when arrangements typically require high trust, and loose networks create more welfare otherwise. Using data on social networks and behavior in dictator games, we document evidence consistent with the quantitative predictions of the model.
We thank Attila Ambrus, Antoni Calvó-Armengol, Pablo Casas-Arce, Rachel Kranton, Avinash Dixit, Drew Fudenberg, Andrea Galeotti, Sanjeev Goyal, Daniel Hojman, Matthew Jackson, Andrea Prat, Tanya Rosenblat, Fernando Vega-Redondo and seminar participants for helpful comments. Markus Mobius is particularly grateful to Tanya Rosenblat for many discussions on trust in social networks over a number of years. The views expressed herein are those of the author(s) and do not necessarily reflect the views of the National Bureau of Economic Research.