BASIS VOLATILITY: IMPLICATIONS FOR HEDGING

Abstract

Abstract Most hedges placed in futures markets must be lifted before contract expiration, which necessitates incurring “basis risk.” The focus of this paper is on quantifying such risk as a function of the timing of a hedge, its duration, distance from contract expiration, hedge life, and other market‐observable variables. The development of basis‐risk profiles provides a hedger with estimates of hedging risks that reasonably can be expected before the actual placement of hedges, thus serving as a useful input in the hedging decision.

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