What is basis risk?
In financial terms, basis risk means the risk associated with hedging. It happens because of the asset that is to be hedged's price and the difference of the asset serving as a hedge. There is a risk that the two investments could experience price changes in vastly different directions.
Key takeaways
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Basis risk is the financial risk associated with hedging when the asset being hedged and the hedging asset experience price changes in different directions.
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Investors calculate basis risk by subtracting the current market price of the asset being hedged from the futures price of the contract.
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Locational risk is a form of basis risk common in commodities markets when a contract's delivery point doesn't align with the seller's needs.
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Basis risks represent price differences between hedges, futures, or relatives and the cash or spot price of hedged assets at any given time.
Where have you heard about basis risk?
Locational risk is another form of basis risk. This happens more in the market of commodities, when a contract’s delivery point is not in line with that needed by the seller. These risks will usually be calculated when offsetting investments in a hedging strategy.
What you need to know about basis risk.
When there is a difference in price between hedge, futures or relatives and the cash or spot price of the assets hedged, at any given point in time, the risks associated with those differences are called basis risks. In order to calculate the amount of the basis risk, investors will need to look at the futures price of a contract and subtract that from the current market price of the asset being hedged.
Find out more about basis risk.
If you are interested in basis risk then you can take a look at out page on spot price.