Correlation coefficient

The correlation coefficient is a relative measure of the correlation between two variables. It measures the degree to which their values are interdependent. In other words, the extent to which changes in the value of one of the variables are associated with changes in the value of the other variable.

Correlation coefficients are widely used in portfolio diversification and hedging calculations.

Mathematically, correlation coefficient is the covariance divided by the product of the standard deviations.

A correlation coefficient of -1 means perfect negative correlation. The two variables always move in opposite directions by a perfectly predictable proportionate amount.

A correlation coefficient of 0 means that there is no correlation between the values of the two variables. The variables are statistically independent.

A correlation coefficient of +1 means perfect positive correlation. The two variables always move in the same direction by a perfectly predictable proportionate amount.

Also known as the Coefficient of correlation.

See also

• Co-efficient
• Correlation
• Covariance
• Delta-normal method
• Mean reversion
• Random walk
• Rho
• Standard deviation