Hedging removes price risk but introduces basis risk — the risk that the hedge instrument and the underlying don't move perfectly together. Basis = Spot Price − Futures Price. At expiry, basis converges to zero, but before expiry it can widen or narrow unpredictably.

Three sources of basis risk:

Cross-hedging: hedging JetBlue stock with an airline ETF — imperfect correlation
Timing mismatch: hedge expires before the exposure ends
Location/quality mismatch: WTI crude futures hedging Brent exposure

Effective hedge ratio adjusts for correlation:

Scenario	Correlation ρ	σ_spot	σ_futures	Optimal h*
Same asset	1.00	20%	20%	1.00
Cross-hedge	0.85	25%	22%	0.97
Weak proxy	0.50	30%	18%	0.83