ERM Glossary: Basis risk

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Basis risk occurs when cash flows from a hedging instrument do not exactly offset cash flows from the instrument(s) being hedged.

It also has a variety of related meanings (in an actuarial context), see e.g. GIRO 2008 Working party on securitisation of non-life insurance, including:

(a)    The residual risk that remains (with a (re)-insurer) in respect of exposures (e.g. perils and territories) covered by the selected protection strategy

(b)   The risk that arises when a counterparty’s payments are based not on (an insurer’s) actual claim payments but on industry averages

(c)    The possibility that (reinsurance) cover might prove insufficient to handle adequately the risk in question because hedging/reinsurance needs have not been precisely identified.

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