Correlation:
Correlation (Corr) is a statistical technique that helps determine whether and how strongly pairs of variables are related to each other. Correlations are helpful as they indicate a predictive relationship. It measures the degrees to which two securities move together in relation to each other.
It is computed into what is termed as the correlation coefficient having a value that must lie between −1 and +1. The correlation between two securities can be determined as the covariance between two securities upon their variances. The formula used to find the correlation is as follows.
Where,
- Corr is the correlation between stocks.
- is the return of stock i.
- is the return of stock j.
- SD is the standard deviation.
To determine:
What returns of two stocks having a correlation of 1 implies about the relative movements in the stock price.
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