Does an Illiquid Derivatives Market Increase or Decrease Basis Risk?
An illiquid derivatives market increases basis risk. Low liquidity means that the futures price can be more volatile and less representative of the true underlying value, leading to greater and more unpredictable divergence from the spot price.
It also makes it harder to execute the necessary trades to manage the hedge.
Glossar
Illiquid Derivatives Market
Characteristic ⎊ An illiquid derivatives market is defined by a scarcity of willing buyers and sellers, leading to wide bid-ask spreads and difficulty in executing trades without significantly impacting prices.
Illiquid
Valuation ⎊ Illiquidity in cryptocurrency, options, and derivatives manifests as a divergence between marked-to-market prices and intrinsic value, often amplified by limited arbitrage opportunities and information asymmetry.
Unpredictable Divergence
Deviation ⎊ Unpredictable divergence, within cryptocurrency derivatives, signifies a statistically significant departure of an asset’s realized volatility from implied volatility forecasts, often exacerbated by limited historical data and non-linear price dynamics.
Illiquid Derivatives
Risk ⎊ Trading Illiquid Derivatives carries a heightened liquidity risk, meaning the inability to quickly enter or exit a position without incurring substantial transaction costs or adverse price slippage.