Basis Risk

Basis risk is the risk that arises when the price of the futures contract used to hedge a position does not move in perfect synchrony with the price of the actual commodity or asset being hedged. The basis is the difference between the spot price and the futures price of a commodity, and it fluctuates over time due to differences in location, quality, delivery terms, and supply-demand dynamics. For an Indian farmer hedging soybean production on NCDEX, basis risk arises if the local mandi price diverges from the exchange futures price at the time of sale. While futures hedging reduces overall price risk, basis risk means the hedge is rarely perfect.