Price risk is the risk of loss (direct loss or lost profit) as a result of adverse market changes.
Price risk is the risk associated with a change in the market price of a financial asset.
Most financial institutions (banks, insurance companies, pension funds) operate more with loan funds (bank and pension deposits, insurance premiums).
The received funds are invested by institutional investors in various markets - stock, government securities, commodity markets, real estate markets.
Each financial institution must, after a period of time, meet its obligations to pay the loan funds.
Due to market fluctuations, the value of a financial asset may change to an unfavourable side for an institutional investor, which will lead to difficulties in fulfilling current obligations to clients or depositors.
Price risk is limited in its scope: unlike currency and interest rate risks affecting almost all participants in financial markets, it is faced only by market participants working with securities or other traded values (precious metals, etc.).
In terms of possible losses likely within normal market conditions, price risk often dominates both interest and currency risk.
Price risk can be divided into three causal components:
- investment risk as impairment risk;
- liquidity risk as risk of non-availability of buyers in case of need of prompt sale of securities;
- hedging risk as the risk that a position cannot be hedged.
This division is to a certain extent conditional, since the events considered and divided into certain types of risks are closely related both in terms of economic meaning and probabilistic parameters, but allows to highlight significant aspects of the phenomena from the point of view of the purposes of the analysis carried out.