What type of risk is measured by basis risk?

Basis risk refers specifically to the risk that arises when there is a difference between the price of a hedging instrument and the price of the underlying asset that is being hedged. This type of risk often occurs in the context of futures and options contracts, where the hedge is not perfectly correlated with the underlying asset. For instance, if a trader uses a futures contract to hedge against price fluctuations in a commodity but the futures price does not move in perfect alignment with the cash price of the commodity, the trader may still incur losses despite the hedge.

In essence, basis risk is a form of financial risk because it is related to the potential for financial losses due to mismatched hedging strategies. This misalignment can result from various factors including changes in supply and demand, regional differences in prices, or changes in the quality of the hedged product, which can all contribute to the divergence between the hedging instrument and the actual asset.

The other options relate to different categories of risk, which do not capture the nuance of basis risk in the context of hedging and associated financial instruments. Understanding the characteristics of basis risk is crucial for managing financial exposures effectively.