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Basis risk

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Basis risk
In a futures market, the Basis Risk is the Risk that the value of a Futures Contract does not move in line with the Underlying exposure. Because a Futures Contract is a Forward agreement, many factors can affect the Basis. These include shifts in the Yield curve, which affect the Cost of carry; a change in the cheapest-to-deliver Bond; supply and demand; and changing expectations in the futures market about the market’s direction. Generally, Basis Risk is the Risk of a Hedge’s price not moving in line with the price of the hedged Position. For example, Hedging Swap positions with bonds incurs Basis Risk because changes in the Swap spread would result in the Hedge being imperfectly correlated. Basis Risk increases the more the instrument to be hedged and the Underlying are imperfect substitutes.
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