The risk that a hedge and the exposure it covers do not move exactly together. It is the residual risk left after hedging.
Where you will meet it
Basis risk comes up in 14 learning outcome notes across the FRM syllabus.
A few of them:
Insurance Companies and Pension Plans FRM Part I · Financial markets and products
“Index-based hedges leave basis risk.”
How Do Firms Manage Financial Risk? FRM Part I · Foundations of risk management
“In practice the main difficulty is basis risk, where the hedge instrument does not move one-for-one with the exposure.”
Fundamentals of Credit Risk FRM Part II · Credit risk measurement and management
“Risk transfer has its own costs, basis risk and counterparty risk, and it may damage client relationships, so retaining small or well-priced exposures can be rational.”
Risk Management for Changing Interest Rates: Asset-Liability Management and Duration Techniques FRM Part II · Liquidity and treasury risk measurement and management
“It assumes assets and liabilities reprice by the same amount, ignoring basis risk between different benchmark rates.”
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