Project Proposal

Subject: 203/Econometrics & Time Series

Topic: Significance of basis in effective risk management: A study of Indian futures market
In the context oI a Iutures market, the diIIerence between Iutures and spot price is termed as the
basis. The signiIicance oI the basis lies in its use as an inIormation source to predict Iuture spot
price oI the asset underlying the Iutures contract. Studying the basis is important because it is
Iundamental to understanding the most important Iunction oI a Iutures market i.e. hedging or
price risk management.

Hedging reduces price risk because the gain (loss) in either (Iutures or spot) market is oIIset by
an equivalent loss (gain) in the other market. However, this is true only to the extent that Iutures
and spot price change by exactly the same magnitude, which may not always be the case. II
Iutures and spot price change by unequal magnitude, i.e. the basis changes, hedging may not be
successIul. Gain in one market may not be equal to loss in the other market resulting in a net
loss. The risk that Iutures and spot price may not change by the same amount is called basis risk
and is deIined as the variance oI the basis. Hedging eIIectiveness depends primarily upon basis
risk, the lower the basis risk, the more eIIective is hedging. Hence, a complete understanding oI
the basis is essential beIore undertaking any hedging activity. In this project, we aim to
undertake such a study oI basis risk Ior Iutures market in India.

Project Guide:
Dr. Kiran Kumar

Group Members:
2027 Sandeep K Biswal
2000 Ashish Baghel