AuthorTopic: COVARIANCE AND CORRELATION
jdollpru
@2005-07-14 13:31:31
i didnt know that probability could be so hard.
I DONT understand it. Can someone explain it to me in english, b/c what i am reading is certainly no that. i am having difficulty particularly in covariance and correlation.

any thoughts would be greatly appreciated.
yeliya
@2005-07-15 04:35:38
I did my statistics 12 years ago while I was an economics student. Reviewing it now does not seem to be that difficult.

If you don't have any statistics before then the best way I'd suggest is to get a textbook with detailed explanations. Any notes are not sufficient in this case.

Good luck!
jdollpru
@2005-07-17 14:11:58
TKS FOR info, i took stat in college, was ok at it, but will take your advice. Tks
Chet
@2005-07-18 10:46:45
Dear jdollpru:

Burton Malkiel outlines these concepts with real-world examples in his "Random Walk Down Wall Street", part 3, chapter on risk. For ex., in his introduction to Correlation, he uses something like an umbrella company and a tanning lotion company to describe companies that may be thought to be "Uncorrelated" when expecting what their returns may be and what the risk of holding both may be(the returns on the common stock, for example, are random variables). The calculations are present in his discussion. The risk of holding the assets(common stock, for ex.) of both the companies may be less than the risk of holding either one. Covariance of return is the calculation of this possibility. Yeliya is right, the textbook "Quant. Methods...", DeFusco, etal. is excellent for this material.

Basically, the covariance terms capture how the "co-movement of returns affect portfolio variance"(DeFusco, etal, pg 198) It is not enough to merely add all the individual variances to find portfolio variance of return.

In addition to the individual variances, we calculate, for example:

Two assets: A and B

Covariance: (Actual A-Mean A)*(Actual B-Mean B)

and add this to the individual variances to find portfolio variance of return.