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xingwei86524
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Posts: 10
Joined: April 11th, 2018, 8:06 pm

Basis Risks

July 11th, 2018, 1:33 am

Hi,

I have a question on terminology regarding "basis risk".

My understanding is that "basis risk" simply means the difference between two quantities.  But I don't know why in quant finance difference is called basis risk?  Can someone please explain?

Thanks
 
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Posts: 3240
Joined: February 3rd, 2011, 2:19 pm

Re: Basis Risks

July 11th, 2018, 5:18 pm

xingwei86524 wrote:
Hi,

I have a question on terminology regarding "basis risk".

My understanding is that "basis risk" simply means the difference between two quantities.  But I don't know why in quant finance difference is called basis risk?  Can someone please explain?

Thanks


The etymology is unclear, but seems to originate in US agricultural futures markets going back to the 1800s. “Your basis” represented the difference between the futures price and the cash price at your local grain elevator or mill. Basis risk would then arise from the uncertainty about this relationship in the future when hedging a (long or short) physical position with futures. From there you can see the generalization to basis risk arising when hedging one financial instrument with another.
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