Incentive for risk sharing and trust formation: experimental and survey evidence from Bangladesh

Abstract

Although interpersonal trust is essential for socioeconomic development, the formation mechanism of trust is not well understood. Using dyadic data from an experiment and a household survey in rural Bangladesh, this study evaluates whether the incentive for risk sharing increases trust between villagers. Incentive for risk sharing in the dyad is characterized by their negative income correlation, large difference in their risk preferences, and large difference in their income volatilities. The empirical results demonstrate supporting evidence for this hypothesis: incentive for risk sharing, particularly negative income correlation, facilitates trust. These findings suggest that the introduction of safety net programmes such as health insurance, which reduce the incentive for risk sharing, may break down trust. This implication could make an important contribution to our understanding of the effect of industrialization on social capital—an effect that has long been discussed.