Meaning
Understanding the difference between expected and actual market movements is crucial in finance.Definition
Basis Risk occurs when a hedged asset’s price and its hedging instrument’s price do not move perfectly together. It’s the risk that futures and spot prices won’t converge at contract expiration.Causes
Different underlying assets, varying maturities, credit quality, or market liquidity issues can cause basis risk. Regulatory changes or unexpected economic events also contribute.Implications
It can lead to unexpected losses for entities employing hedging strategies, reducing their risk mitigation effectiveness. Exposure to market fluctuations persists despite hedging.Author
