How Does Arbitrage Help to Minimize Basis Risk in Futures Markets?

Arbitrageurs monitor the basis ▴ the price difference between the futures contract and the underlying spot asset. If the futures price deviates significantly from the theoretical price (spot plus cost of carry), arbitrage opportunities arise.

Arbitrageurs execute simultaneous trades (e.g. buying spot and selling futures) to profit from this mispricing. Their actions push the two prices back into alignment, thus minimizing the basis risk for other market participants.