Firm reputation plays a vital role in financial networks, and it is especially impactful in times of market stress or a financial crisis. This paper uses a novel theoretical model to study reputational dynamics in financial networks, taking into account that firms begin with incomplete information, learn about others over time, and update their connections as their beliefs evolve. In our model, stronger firms develop high reputations and remain in the network, while weaker firms will eventually drop in reputation and get shut out. We show that more information revelation during crisis generally increases network fragility and harms social welfare. It is thus crucial to maintain anonymity among firms during a crisis. Certain network structures, such as core-periphery networks, are more systemically resilient against negative informational effects.

Abstract Central counterparty (CCP) default waterfalls act as the last lines of defense in over-the-counter markets by managing and allocating resources to cover payment defaults. This article examines the impact of variations in waterfall design on financial system losses in the presence of payment network dependencies and frictions in the cleared and noncleared portion of the system. Through the development of a structural model, we draw several theoretical conclusions about the effectiveness of CCP default waterfalls under severe payment stress. These findings are empirically quantified by testing the model using supervisory data for the U.S. credit default swap market.