Equity basis risk

Tong cautions Winthrop that there is a potential pitfall with the proposed request when it comes time to analyze performance. She discloses to Winthrop that equity index futures returns can differ from the underlying index, primarily because of cor- porate actions such as the declaration of dividends and stock splits.

The risk that Tong discloses regarding the equity futures strategy is most likely:

A .basis risk.
B .currency risk.
C .counterparty risk.

A is correct. Basis risk results from using a hedging instrument that is imper- fectly matched to the investment being hedged. Basis risk can arise when the underlying securities pay dividends, because the futures contract tracks only the price of the underlying index. Stock splits do not affect investment performance comparisons.

My question is: in the answer statement, why the basis risk rises when paying dividend. My understanding is dividend paid, and stock price drop, at the same time, future price drop as well. Basis risk should not rise?

Your total return for holding stock includes both price changes and dividend yield.
But with futures, only the price changes matter.