This paper models two key channels of contagion in nancial systems by which default may spread from one institution to another. The primary focus is on how losses can potentially spread via the complex network of direct counterparty exposures following an initial default. But, as Cifuentes et al (2005) and Shin (2008) stress, the knock-on effects of distress at some nancial institutions on asset prices can force other nancial entities to write down the value of their assets, and we also model the potential for this effect to trigger further rounds of default. Contagion due to the direct interlinkages of interbank claims and obligations may thus.
