What Is the Risk of Using an Index Price Based on Illiquid Exchanges?

The primary risk is that the index price becomes highly susceptible to manipulation. On an illiquid exchange, a relatively small trade can cause a large price movement.

If this exchange's price is included in the index, it can disproportionately skew the final settlement price, leading to unfair outcomes for futures traders. It also increases the overall basis risk because the index may not reflect the price on more liquid exchanges.