3 Papers Exploring Trust and Financial Transactions: Key Findings

Paola Sapienza Video 3 Papers Exploring Trust and Financial Transactions: Key Findings


Contributor / Paola Sapienza

Donald C. Clark/HSBC Chair in Consumer Finance
Professor of Finance
Kellogg School of Management / Finance

Italy was the first place where trust was studied by sociology, so when economists wanted to study the relationship between trust and financial transactions, they started in Italy. Research shows that in areas where there is limited social capital and little trust, people tend to use fewer financial contracts, are less likely to invest in the stock market and are less likely to buy insurance products. Research also shows that the level of bilateral trust between citizens of a given country and citizens of another country impacts the amount of trade between the two countries as well as foreign direct investment.


When economists wanted to study the relationship between trust and the existence of financial transaction and the importance of trust for financial markets, they faced an important challenge: it’s really hard to measure causal relationships in environments that are very different along many other dimensions.

So, economists decided to go to Italy. Why Italy? Well, Italy was the first place where trust was studied by sociologists.

Back in 1950, Banfield wrote a very famous book, which is called The Moral Basis of a Backward Society, where he identified the characteristic values, cultural values of societies where there is a very limited level of trust.

More than 40 years later, his student Robert Putnam, in 1993, wrote a very famous book called ‘Making Democracy Work’ in which he argued that social capital and trust are a necessary ingredient for democracy to work and went to Italy to study that.

Italy is a very interesting country because it’s been unified for a relatively short time—150 years. Legally, regulatory, the views are the same, so it’s the perfect setting to study trust because trust has been very different across regions.

Financial economists borrowed from the sociologists and political scientists this incredible laboratory, Italy, and decided to study the effect of different levels of generalized trust on financial contracts.

Generalized trust defines how much people trust other people they don’t know. It’s generally measured as the answer to the following question: Generally speaking, do you think you can trust other people, or you can never be too careful about it?

The answer to this question has been linked to several economic outcomes. More specifically, financial economists wondered whether there is a connection between generalized trust and finance.

BUMPER: The Relationship between Generalized Trust and Financial Contracts

In the paper, “The Role of Social Capital in Financial Contracts,” we studied the different levels of generalized trust on the availability and use of financial contracts in different regions.

We found that in areas where there is very limited social capital and very limited trust, people tend to use less of those financial contracts that we consider basic, such as writing a check, opening a bank account, investing in stock, borrowing money.

Why is that the case? Because trust is very important in these financial transactions, as it is required for people to depart with their money.

And in fact, the results show a remarkable correlation between the extensive level of generalized trust in a given area and the availability and use of those contracts in certain areas.

So, in the paper, “Trusting the Stock Market,” the link is actually closer. We look at a sample of Dutch households all living in the same countries with the same legal views but with different level of trust. It’s a representative sample of household investors.

And we ask the question whether generally speaking, they trust other people and linked the answer to this question to their financial investment.

We find that individuals that have low levels of trust are less likely to invest in the stock market. They’re also less likely to buy insurance products.

And this is a very important result in the financial literature because of the puzzle, a generalized puzzle on why some people stay away altogether from the stock market even when they would benefit from it.

The concept that is developed in this paper is very much related to an important idea in economics that if we don’t trust the rule of the game or we don’t trust the players playing the game with us, we may stay out of it altogether.

By staying out of it altogether, we’re never going to learn that indeed it’s beneficial for us to participate, and this lack of participation therefore is indeed pervasive but also persistent over time.

BUMPER: The Role of Culture in Generalized Trust

Having established that the level of generalized trust in a given area affects the use and availability of financial contracts, that the individual level of generalized trust toward others affect his willingness to invest in the stock market, a follow-up question was whether bilateral trust—so, this is a little bit more special trust.

It’s still general in the sense that it’s a trust that is applied to different groups, and it’s generally measured as how much do you trust people from France? Or how much do you trust people from this other country? Or how much do you trust people from your own country?

So, the question is still a generalized trust question but is applied to different groups. And the question the paper “Cultural Biases in Economic Exchange” tried to answer was whether this bilateral level of generalized trust affected the willingness people have to enter in specific transactions.

The results are remarkable. We find that absorbing every other bilateral characteristics like language, specificity, legal contracts, and so on, controlling for all those characteristics, the level of bilateral trust between citizens of a given country and citizens of another country affect the composition of the portfolio, the amount of trade between the two countries, and foreign direct investment.

So, we looked at whether the extent to which citizens of a given country trust citizens of another country affects the willingness to invest in stocks of that specific country, the willingness to trade with the country, and the willingness to do foreign direct investment.

We find that bilateral trust is correlated with the composition of the portfolio of mutual fund managers in the following way: The higher the level of trust between Country I and Country J, the bigger the weight of Country J’s stocks in the portfolios of Country I.

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Trust and Economic Prosperity: A Finance Perspective

Contributor / Paola Sapienza
Paola Sapienza Finance Generalized Trust,Economic Exchange,Rationality In 1972, Ken Arrow, Nobel Prize–winning economist, said that virtually every commercial transaction has within itself an element of trust. Indeed, he actually went on saying that it can be plausibly argued that much of the economic backwardness in the world can be explained by the lack of mutual confidence.

Since then, economists have correlated generalized trust, the concept that whether people tend to trust each other in an anonymous way with economic growth, and they found the remarkable correlation between these two variables.

It was actually, though, quite puzzling why there was such a strong correlation between the way people tend to interact in certain communities and economic prosperities.

So, economists start wondering, what is the missing link between these two variables?

One of the hypotheses postulated is that the missing link could be finance. Why? Well, in finance, a fundamental element is credit. And indeed, the word “credit” comes from ‘credere’ in Latin, which means to trust. Why is that so?

It takes a lot of trust for people to depart with their money in exchange for a promise. And this is fundamentally the way finance works.

We delegate a broker, an insurance company, a bank, we put our money in their in their hands in exchange of a future promise. And for a long time, we’re not going to see the money that we gave to them.

Now, finance is very, very important for economic prosperity. We know from years of research that without finance, allocation of resources doesn’t happen properly and economic prosperity doesn’t happen.

BUMPER: Exploring Trust through the Stock Market

Given the hypothesis postulated by economists that finance is the missing link between trust and economic prosperity, economists start investigating empirically whether indeed trust facilitated development of financial contracts in various economies.

They started studying the willingness people have to invest in the stock market.

Investment in the stock market has been one of the puzzling features in financial economics, because we know by observation that many people deliberately stay away from the stock market even when they would benefit from investing in it.

Therefore, it was reasonable to think whether, besides all the other variables that economists generally considered as determinant of investing in the stock market—such as risk aversion—trust was a big player in this decision.

Economists studied whether people that have lower generalized trust are less likely to invest their money in risky investment, such as putting their money in the stock market or even opening a checking account.

And they found a remarkable correlation between the level of generalized trust that individuals have with their willingness to invest their own money.

They also found a remarkable correlation between areas where there is a generalized low level of trust and the development of financial markets in general, suggesting that indeed this link between trust and economics could be indeed going through finance.
Paola Sapienza Video - How Culture Impacts Financial Markets in the Absence of Trust

How Culture Impacts Financial Markets in the Absence of Trust

Contributor / Paola Sapienza
Paola Sapienza Finance Economic Exchange BUMPER: Understanding Culture and Trust

In the absence of trust, people are willing to engage in transactions, especially in financial transactions. But where is trust coming from, and how is it spread across countries?

We know there are remarkable differences across countries, with northern European countries being very high on the trust scale and some Latin American countries being at the bottom of the distribution.

In fact, what we know, and it’s very interesting, is that immigrants from countries with high trust, when they move to countries with lower trust, they tend to hold onto their original trust level. And this suggests that our upbringing has something to do with how much we trust.

So, if I think about banks, insurance companies, trust is a fundamental ingredient to convince customers to depart themselves with their money and indeed trust the financial institution that they would do the right thing.

BUMPER: Winning Customer Trust: Dealing with Culture and Bias

It’s also important to understand that when dealing with different ethnic groups, different social background, where is the level of trust or mistrust coming from and indeed understand how this could be ameliorated at some level.

For example, we have evidence that shows that people tend to trust more people that look much more like them. So, diversity in facing customers could be an important mechanism to generate trust.

If we have that financial institutions are too homogeneous and they don’t reflect the demographic of their potential customers, it’s hard somehow to have customers relate to the specific experience.

But generally speaking, evidence shows that lack of trust indeed makes it really, really hard for some customers to walk into financial institutions.

And so, dealing with this reality and understanding the different reasons why people may or may not trust is a very important aspect of every customer interaction in the financial service.

We need to make sure that we unbias our customer force to make sure that they don’t bias themselves to favor some specific people.

But we also know that our customers, they have biases, and they tend to trust less people that look very different.

For example, a big debate among executives nowadays has been to the extent to which, given the fact that women are one of the largest buyers in the US nowadays of insurance products, why our customer force doesn’t mimic that, given the fact that they’re going to be the recipient of effort to convince them to buy some of this product.

Given the fact that women are among majority buyers of insurance, the question is whether a customer force that is more balanced and reflects this demographic should really be a conscious decision on the side of executives.

Similarly, think about the ethnic changing demographic of the customer base—to what extent corporate America should reflect that in order to, A, be able to understand better the needs of this group, and B, in order to really inspire a level of trust and confidence in the financial institution that we know is fundamental for a good relationship to start.
Healthcare providers must recognize the importance of trust and communication in building stable relationships with patients.

Trusting Healthcare Providers and Institutions: Key Findings

Contributor / Kelly Michelson
Kelly Michelson Pediatrics Communication,Distrust,Healthcare,Measurement Research about trust in the healthcare setting has generally taken two approaches: the first is to look at it in a qualitative fashion, so to hear personal anecdotes and learn what we can from that; and the other is to look at it in a more quantitative fashion, using scales and measures to see how trust relates with specific outcomes or specific variables.

From the qualitative research, we know that things like developing partnerships, developing relationships, demonstrating competence are all very important components of establishing trust in the relationship.

Most of the quantitative data related to trust in a healthcare setting use trust scales to compare a measure of trust to a particular variable — looking at things like, do women tend to be more trusting than men of their healthcare provider? Are there racial differences related to trust? Are there differences in providers’ and healthcare settings’ relationship to trust?

And these concepts help us to think about how we act — in a clinical setting, for example — and what we teach trainees about how to build trusting relationships with their patients or with others in the healthcare team.

BUMPER: Trust and Communication

Much of what we know about trust in the pediatric intensive care unit comes from literature that looks at communication and how communication unfolds in this particular setting.

We know from some qualitative work, from Carnevale et al., that trust is a really important part of communication in the pediatric intensive care unit.

These authors interviewed physicians, nurses, and parents about communication, identified three different components of communication. And of note, one of them was relational communication. And one key factor in developing relational communication that they identified was fostering trust.

And in another work by Ames et al., we find that trust is not only an important component for healthcare providers to focus on but also for parents.

In this work, the authors interviewed parents of children who were in the pediatric intensive care unit and asked them about their roles. And one of the three roles that they identify was actually that the parents should be trying to establish a trusting relationship with the healthcare providers in the PICU.

In another study done by Vivian et al., we learned about the importance of communication among staff members in the pediatric intensive care unit.

In that study, staff members were interviewed, and we found that poor communication among caregivers within in the intensive care unit can impact trust and therefore impact how they care for patients.

So, again, we’re seeing the importance of trust between providers and patients (or, in my case, parents) but also among providers.

BUMPER: Trust in Critical Decision-Making

In terms of decision-making in the intensive care unit, much of the literature has focused on issues related to pretty challenging decisions for children who are very sick, things like withdrawing or withholding life-sustaining efforts if a child was seriously ill — some pretty serious decisions.

Some of the research I’ve done, for example, has looked at what kind of influencers contribute to a parent’s deciding whether or not to withhold or withdraw life-sustaining therapies if their child was so sick that that became something to consider.

And what I found was that distrust was one of nine important factors that parents are weighing in terms of making that kind of decision.

In another study, Meert et al. interviewed parents of children who had died in the pediatric intensive care unit to find out more about their experiences. And they found that parents who felt that clinicians were withholding information also had a sense of betrayal or distrust towards those physicians.

BUMPER: Enhancing Trust in the Intensive Care Unit

But it’s really important not just to know what happens in the intensive care unit and where trust fits into communication and decision-making; now that we have all that information, we really want to try to impact trust and to enhance better trust and better communication and hence better decision-making in the intensive care unit.

For example, Curtis et al. looked at an intervention where he tried to change multiple components of what was going on in the intensive care unit, including identifying champions for this work, providing feedback to clinicians.

Interestingly, he didn’t find that that intervention changed his primary outcome.

In another effort done by Lautrette et al., they actually educated clinicians about how to conduct a family conference.

And they came up with this mnemonic called VALUE, and each of the letters stand for something different — specifically that you should value and appreciate what the family is saying during a meeting, acknowledge their feelings and emotions, that you should listen to what they say, that you should try to understand their situation and their values, and that you should elicit questions from them.

So, they actually taught clinicians a little bit about how to focus their communication during family conferences in the intensive care unit. And they actually did find a difference.

They found that for families who had family conferences with clinicians who were trained in this manner, those surrogates to the patients in adult ICUs had less anxiety and depression after their loved one had died and less symptoms of post-traumatic stress.

Other pages in Videos:

Pages in The Trust Project at Northwestern University