Definition
Correlation measures the degree to which two assets move together, ranging from -1 to +1. A correlation of +1 means perfect positive correlation (move together). A correlation of -1 means perfect negative correlation (move opposite). Zero correlation indicates no linear relationship. Correlation is fundamental to portfolio diversification - combining assets with low or negative correlations reduces overall portfolio risk. However, correlations can change over time, often increasing during market stress.
Formula
Example
Stocks and bonds historically have low or negative correlation. When stocks fall during economic uncertainty, bonds often rise as investors seek safety. A portfolio of both has lower volatility than either alone.
FAQ
What is Correlation?
A statistical measure of how two investments move in relation to each other.
How do you calculate Correlation?
A common formula for Correlation is: Correlation = Cov(X,Y) / (σX × σY)
Why is Correlation important?
Correlation helps investors evaluate portfolio management and make more informed decisions.