Covariance and correlation cofficient

Mmhrosoha14y ago

Hi all,
A bit confused about covariance. ACCA technical article "the risk and return relationship" (published in May 2004) mentions that covariance is an absolute measure. To domenstrate this it's calulated giving answers 20, -20 and 0 for the three portfolios in the example used.

However BPP text book mentions something totally opposite. It states that covarinace is a relative measure and could be anywhere between -1 and +1.

Can someone advice whether covariance is absoulte or relative measure and how it's relates with correlation cofficient (if there is a formula please state).

Iimarsalan14y ago#1

i ll be denoting standard deviation by ~
in bpp book its mentioned ..... correlation coeffeicent = covariance between A and B divided by ( ~ of investment A multiplied by ~ investement b ) ..... answer will be between -1 and +1 ..... covariance is absolute .... and correlation coeffecient is relative as it tells u by how much the returns of the two investment move in line or against each other......... its like u know that some1 got 750 marks... u dont know he performed better or worse until ur told the maximum marks available... for example maximum available is 1000..... u calcualted the percentage 75 percent... now u know that he he performed reasonably well.... 750 alone has no value .... althought 75 percentage sum value of determining the performance....
so correlation coefficient shows u the strength of covariance between the returns of two investments ..... just like percentage shows u the performance....
-1 is perfectly negative....+1 is perfectly positive

very bad at teaching but hope it helps....

Mmhrosoha14y ago#2

Thanks dude, that was extremely helpful.

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