Hedging Effectiveness

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The extent to which hedging an investment actually reduces risk. There are a large number of hedging strategies one can use. For example, one may take a long position on a security and then sell short the same security. However, some strategies may be forms of naive diversification, which reduce hedging effectiveness. In an extreme example, if one buys a stock and then short sells a bond in a completely different industry, one is more likely to increase risk rather than decrease it.

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