A Model of Trust Building with Anonymous Re-Matching

33 Pages Posted: 28 Jun 2016 Last revised: 17 Jun 2018

See all articles by Dong Wei

Dong Wei

University of California, Berkeley - Department of Economics

Date Written: January 24, 2018

Abstract

This paper studies a repeated lender-borrower game with anonymous re-matching (that is, once an ongoing relationship is terminated players are rematched with new partners and prior histories are unobservable). We propose an equilibrium refinement based on two assumptions: (a) default implies termination of the current relationship; (b) in a given relationship, a better loan-repayment history implies weakly higher continuation values for both parties. This refinement captures the idea of "justifiable punishments" in repeated games. We show that, under these conditions, if the discount factor and the re-matching probability are large enough, then the loan size is strictly increasing over time along the equilibrium path of all non-trivial equilibria. As such, this paper helps explain gradualism in long-term relationships, especially credit relationships.

Keywords: gradualism, trust building, moral hazard, social equilibrium, credit relationships

JEL Classification: C72, C73, D86

Suggested Citation

Wei, Dong, A Model of Trust Building with Anonymous Re-Matching (January 24, 2018). Available at SSRN: https://ssrn.com/abstract=2801706 or http://dx.doi.org/10.2139/ssrn.2801706

Dong Wei (Contact Author)

University of California, Berkeley - Department of Economics ( email )

579 Evans Hall
Berkeley, CA 94709
United States

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