How Does the Concept of ‘Basis Risk’ Affect an OTC Desk’s Hedging Strategy?

Basis risk is the risk that the price of the asset being hedged (the spot asset) and the price of the hedging instrument (e.g. a futures contract) do not move in perfect correlation. An OTC desk faces basis risk if the spread between the spot price and the futures price widens or narrows unexpectedly, potentially leading to losses on the hedged position despite the spot trade being covered.