The decision to invest in stocks requires not only an assessment of the risk-return trade-o
given the existing data, but also an act of faith (trust) thatthe data in our possession are
reliable, that the overall system is fair. Episodes like thecollapse of Enron may change not only
the distribution of expected payos, but the fundamental trust in the system that delivers those
payos. Most of us will not enter a three-card game played on the street, even after observing
a lot of rounds (and thus getting an estimate of the \true” distribution of payos). The reason
is that we do not trust the fairness of the game (and the personplaying it). In this paper
we claim that for many people (especially people unfamiliarwith nance), the stock market is
not intrinsically dierent from the three-card game. They need to have trust in the fairness
of the game and in the reliability of the numbers to invest in it. We focus on trust to explain
dierences in stock market participation across individuals and across countries.
We dene trust as the subjective probability individuals attribute to the possibility of being
cheated. This subjective probability is partly based on objective characteristics of the nancial
system (the quality of investor protection, its enforcement, etc.) that determine the likelihood of
frauds such as Enron and Parmalat. But trust reects also thesubjective characteristics of the
person trusting. Dierences in educational background rooted in past history (Guiso, Sapienza,
and Zingales (GSZ), 2004a) or in religious upbringing (GSZ,2003) can create considerable
dierences in levels of trust across individuals, regions,and countries. This dierence between
subjective and objective beliefs can persist because learning about the true probability of a very
rare event takes very long time.
These individual priors play a bigger role when investors are unfamiliar with the stock
market or lack data to assess it. But they are unlikely to fadeaway even with experience and
data. If trust is suciently low, very few will participate and accumulate enough information
to update a (possibly wrong) prior. Furthermore, when mistrust is deeply rooted, people may
be doubtful about any information they obtain and disregardit in revising their priors. For
example, data from a 2002 Gallup poll show that roughly 80 percent of respondents from some
Muslim countries (Pakistan, Iran, Indonesia, Turkey, Lebanon, Morocco, Kuwait, Jordan, and
Saudi Arabia) do not believe that Arabs committed the September 11 attacks (Gentzkow and
Shapiro, 2004).
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