Definition of Basis risk:
Offsetting vehicles are generally similar in structure to the investments being hedged, but they are still different enough to cause concern. For example, in the attempt to hedge against a two-year bond with the purchase of Treasury bill futures, there is a risk the Treasury bill and the bond will not fluctuate identically.
In asset liability management, risk that changes in interest rates will reprice interest-incurring liabilities differently from repricing the interest-earning assets, thus causing an asset-liability mismatch.
Basis risk is the financial risk that offsetting investments in a hedging strategy will not experience price changes in entirely opposite directions from each other. This imperfect correlation between the two investments creates the potential for excess gains or losses in a hedging strategy, thus adding risk to the position.
How to use Basis risk in a sentence?
- Basis risk occurs when a hedge is imperfect, so that losses in an investment are not exactly offset by the hedge.
- Certain investments do not have good hedging instruments, making basis risk more of a concern than with others assets.
- Basis risk is the potential risk that arises from mismatches in a hedged position.
Meaning of Basis risk & Basis risk Definition