Correlation Analysis
The mathematical measure of relationships.
Correlation Analysis quantifies the degree to which two variables move in relation to each other. In finance, this is typically used to measure how an asset moves relative to a benchmark (like the S&P 500) or another asset (like Gold vs. USD). Understanding correlation is the bedrock of portfolio diversification.
The Coefficient (r)
Interpreting 'r'
- +1.0: Perfect Positive Correlation (Move exactly together).
- 0.0: Uncorrelated (Move independently).
- -1.0: Perfect Negative Correlation (Move exactly opposite).
Correlation Breakdown
Correlations are not static. During market crashes, correlations tend to spike towards +1, meaning 'diversification disappears when you need it most.' This phenomenon is known as correlation breakdown.
Key Takeaways
Correlation does not equal causation.
Low correlation assets reduce portfolio volatility.
Dynamic correlations require constant monitoring.
Correlation Analysis
The mathematical measure of relationships.
Correlation Analysis quantifies the degree to which two variables move in relation to each other. In finance, this is typically used to measure how an asset moves relative to a benchmark (like the S&P 500) or another asset (like Gold vs. USD). Understanding correlation is the bedrock of portfolio diversification.
Table of Contents
The Coefficient (r)
Interpreting 'r'
- +1.0: Perfect Positive Correlation (Move exactly together).
- 0.0: Uncorrelated (Move independently).
- -1.0: Perfect Negative Correlation (Move exactly opposite).
Correlation Breakdown
Correlations are not static. During market crashes, correlations tend to spike towards +1, meaning 'diversification disappears when you need it most.' This phenomenon is known as correlation breakdown.
Key Takeaways
Correlation does not equal causation.
Low correlation assets reduce portfolio volatility.
Dynamic correlations require constant monitoring.
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