When is close relationship breaks-down in hedging reasons

Question

When is the close relationship breaks-down in hedging reasons?

Answer 1

If two underlyings are extremely highly correlated you can utilize one as a proxy for another for hedging reasons. You would then only be exposed to origin risk. Be careful along with this as there may be times while the close relationship breaks-down. When you have many financial instruments which are uncorrelated with each other so, you can construct a portfolio with much fewer risks than any one of the instruments independently. With such a large portfolio you can theoretically decrease risk to negligible levels. Though, this isn’t strictly hedging it achieves similar goal.