Correlation coefficient

Definition

A correlation coefficient is a statistical measure that quantifies the strength and direction of a relationship between two variables. It ranges from -1 to 1, indicating perfect negative and positive correlations respectively.

5 Must Know Facts For Your Next Test

1. A correlation coefficient close to 0 indicates a weak or no linear relationship between variables.
2. Positive values indicate that as one variable increases, the other also tends to increase.
3. Negative values indicate that as one variable increases, the other tends to decrease.
4. The most commonly used correlation coefficient in finance is Pearson's correlation coefficient.
5. Correlation does not imply causation; it only measures the degree of association between variables.

Review Questions

• What does a correlation coefficient of -0.8 indicate about two financial variables?
• How do you interpret a correlation coefficient of zero?
• Why is it important to remember that correlation does not imply causation?

Related terms

Regression Analysis:

A statistical process for estimating relationships among variables.

Covariance:

A measure of how much two random variables change together.

Pearson Correlation Coefficient: A measure of linear correlation between two sets of data.