diff --git a/modules/swagger-parser/src/main/java/io/swagger/parser/processors/PathsProcessor.java b/modules/swagger-parser/src/main/java/io/swagger/parser/processors/PathsProcessor.java
index 6e37fe8f6d..c0e8250e4e 100644
--- a/modules/swagger-parser/src/main/java/io/swagger/parser/processors/PathsProcessor.java
+++ b/modules/swagger-parser/src/main/java/io/swagger/parser/processors/PathsProcessor.java
@@ -5,6 +5,7 @@
 import io.swagger.models.parameters.Parameter;
 import io.swagger.models.properties.Property;
 import io.swagger.models.properties.RefProperty;
+import io.swagger.models.refs.RefFormat;
 import io.swagger.parser.ResolverCache;
 import io.swagger.parser.SwaggerResolver;
 
@@ -143,12 +144,12 @@ protected void updateLocalRefs(Parameter param, String pathRef) {
 
     protected void updateLocalRefs(Model model, String pathRef) {
         if(model instanceof RefModel) {
-            RefModel refModel = (RefModel) model;
-            if(isLocalRef(refModel.get$ref())) {
-                refModel.set$ref(computeLocalRef(refModel.get$ref(), pathRef));
-            }/*else if(isLocalRef(refModel.getOriginalRef())) {
-                    refModel.set$ref(computeLocalRef(refModel.getOriginalRef(), pathRef));
-            }*/
+            RefModel ref = (RefModel) model;
+            if(ref.getRefFormat() == RefFormat.INTERNAL) {
+                ref.set$ref(computeLocalRef(ref.get$ref(), pathRef));
+            } else if (ref.getRefFormat() == RefFormat.RELATIVE) {
+                ref.set$ref(computeRelativeRef(ref.get$ref(), pathRef));
+            }
         }
         else if(model instanceof ModelImpl) {
             // process properties
@@ -176,22 +177,23 @@ else if(model instanceof ArrayModel) {
     protected void updateLocalRefs(Property property, String pathRef) {
         if(property instanceof RefProperty) {
             RefProperty ref = (RefProperty) property;
-            if(isLocalRef(ref.get$ref())) {
+            if(ref.getRefFormat() == RefFormat.INTERNAL) {
                 ref.set$ref(computeLocalRef(ref.get$ref(), pathRef));
-            }/*else if(isLocalRef(ref.getOriginalRef())) {
-                ref.set$ref(computeLocalRef(ref.getOriginalRef(), pathRef));
-            }*/
-        }
-    }
-
-    protected boolean isLocalRef(String ref) {
-        if(ref.startsWith("#")) {
-            return true;
+            } else if (ref.getRefFormat() == RefFormat.RELATIVE) {
+                ref.set$ref(computeRelativeRef(ref.get$ref(), pathRef));
+            }
         }
-        return false;
     }
 
     protected String computeLocalRef(String ref, String prefix) {
         return prefix + ref;
     }
+
+    protected String computeRelativeRef(String ref, String prefix) {
+        int index = prefix.lastIndexOf('/');
+        if (index > 1) {
+            return prefix.substring(0, index + 1) + ref;
+        }
+        return ref;
+    }
 }
diff --git a/modules/swagger-parser/src/test/java/io/swagger/parser/FileReferenceTest.java b/modules/swagger-parser/src/test/java/io/swagger/parser/FileReferenceTest.java
index c7607bbf8f..8157f4be6c 100644
--- a/modules/swagger-parser/src/test/java/io/swagger/parser/FileReferenceTest.java
+++ b/modules/swagger-parser/src/test/java/io/swagger/parser/FileReferenceTest.java
@@ -117,6 +117,29 @@ public void testIssue316() {
         assertEquals(ref.get$ref(), "#/definitions/Foobar");
     }
 
+    @Test
+    public void testIssue1223() {
+        SwaggerDeserializationResult result = new SwaggerParser().readWithInfo("./src/test/resources/nested-file-references/issue-1223.yaml", null, true);
+        assertNotNull(result.getSwagger());
+
+        Swagger swagger = result.getSwagger();
+        assertNotNull(swagger.getPath("/events"));
+        Path path = swagger.getPath("/events");
+        assertNotNull(path.getGet());
+        Operation get = path.getGet();
+        assertEquals(get.getOperationId(), "getEvents");
+        assertEquals(swagger.getDefinitions().size(),3);
+        assertEquals(swagger.getDefinitions().get("Foobar").getProperties().size(), 1);
+        assertEquals(swagger.getDefinitions().get("StatusResponse").getProperties().size(), 1);
+        assertEquals(swagger.getDefinitions().get("Paging2").getProperties().size(), 2);
+        Model model = swagger.getDefinitions().get("Paging2");
+
+        Property property = model.getProperties().get("foobar");
+        assertTrue(property instanceof RefProperty);
+        RefProperty ref = (RefProperty) property;
+        assertEquals(ref.get$ref(), "#/definitions/Foobar");
+    }
+
     @Test
     public void testIssue323() {
         SwaggerDeserializationResult result = new SwaggerParser().readWithInfo("./src/test/resources/nested-file-references/issue-323.yaml", null, true);
diff --git a/modules/swagger-parser/src/test/resources/nested-file-references/common/eventsWithPagingInSubdir.yaml b/modules/swagger-parser/src/test/resources/nested-file-references/common/eventsWithPagingInSubdir.yaml
new file mode 100644
index 0000000000..5e23406f2b
--- /dev/null
+++ b/modules/swagger-parser/src/test/resources/nested-file-references/common/eventsWithPagingInSubdir.yaml
@@ -0,0 +1,12 @@
+get:
+  description: A list of events
+  operationId: getEvents
+  responses:
+    200:
+      description: OK
+      schema:
+        type: object
+        properties:
+          paging:
+#            type: string
+            $ref: 'paging2.yaml#/Paging2'
diff --git a/modules/swagger-parser/src/test/resources/nested-file-references/common/paging2.yaml b/modules/swagger-parser/src/test/resources/nested-file-references/common/paging2.yaml
index 41d22e8ed5..59260b0ec3 100644
--- a/modules/swagger-parser/src/test/resources/nested-file-references/common/paging2.yaml
+++ b/modules/swagger-parser/src/test/resources/nested-file-references/common/paging2.yaml
@@ -3,4 +3,4 @@ Paging2:
     total_items:
       type: integer
     foobar:
-      $ref: '../common2/bar.yaml#/Foobar'
+      $ref: './common2/bar.yaml#/Foobar'
diff --git a/modules/swagger-parser/src/test/resources/nested-file-references/issue-1223.yaml b/modules/swagger-parser/src/test/resources/nested-file-references/issue-1223.yaml
new file mode 100644
index 0000000000..5bba8b3f41
--- /dev/null
+++ b/modules/swagger-parser/src/test/resources/nested-file-references/issue-1223.yaml
@@ -0,0 +1,22 @@
+swagger: '2.0'
+info:
+  title: Test API
+  version: '1'
+host: example.com
+basePath: /api/v1
+schemes:
+  - https
+consumes:
+  - application/json; charset=utf-8
+produces:
+  - application/json; charset=utf-8
+
+paths:
+  /events:
+    $ref: './common/eventsWithPagingInSubdir.yaml'
+
+definitions:
+  StatusResponse:
+    properties:
+      http_code:
+        type: integer