Game theory assumes that players will renege on any agreement that does not serve their interests at each stage of the game. Indeed, rational players would not enter such agreements in the first place. In reality, however, things are more complex. People decide whether to trust others, or to vindicate another's trust in them, depending upon whom they are dealing with and the circumstances of the transaction. As Kevin McCabe, Dan Houser, and Vernon Smith of the University of Arizona put it, we keep mental accounts of the goodwill we owe to others and the goodwill others owe to us.
Goodwill accounting may underpin many interpersonal exchanges, but how can it be extended to impersonal exchange, such as trading over the Internet? Internet traders can adopt any on-line persona and change it at will. We have no way to know whom we are dealing with and no way of marking them out for punishment if they cheat us.
Internet trading is one of the most impersonal forms of exchange: Internet traders can adopt any on-line persona and change it almost at will. We have no way to know whom we are dealing with and no way of marking them out for punishment if they cheat us. To overcome this problem, many Internet trading houses offer a public forum where traders can report on each other: this exposes bad dealings, and gives honest traders a reason to maintain their identity and build up a good reputation. Other trading houses rely on more cumbersome safeguards, such as third party clearinghouses and escrow services.
How effective are these alternative safeguards? Kevin McCabe, Dan Houser, and Vernon Smith, all of the University of Arizona will test both experimentally, using a computer-mediated trust game played out under different institutional conditions. The experiments will show whether more trade takes place in the presence of safeguards, and whether traders gravitate toward one kind of safeguard over the other. The experiments should shed light on the institutional underpinnings of trust, and provide some practical tips for the design of Internet exchanges.