2005 Reports

Trust, reciprocity and favors in cooperative relationships

Bagwell, Kyle; Abdulkadiroglu, Atila

We study trust, reciprocity and favors in a repeated trust game with private information. In our main analysis, players are willing to exhibit trust and thereby facilitate cooperative gains only if such behavior is regarded as a favor that must be reciprocated, either immediately or in the future. Private information is a fundamental ingredient in our theory. A player with the ability to provide a favor must have the incentive to reveal this capability, and this incentive is provided by an equilibrium construction in which favors are reciprocated. We also offer the novel prediction that the size of a favor owed may decline over time, as neutral phases of the relationship are experienced. Indeed, a favor-exchange relationship with this feature offers a higher total payoff than does a simple favor-exchange relationship. We also describe specific circumstances in which a relationship founded on favor exchange may be inferior to a relationship in which an infrequent and symmetric punishment motivates cooperative behavior. Finally, we show that a hybrid relationship, in which players begin with a honeymoon period and then either proceed to a favor-exchange relationship of suffer a symmetric punishment, can also offer scope for improvement.