Title: Knut Larsen: Demystifying Correlation
1Knut LarsenDemystifying Correlation
- Simple techniques for diagnosing and quantifying
correlation
2Why Diagnose Correlation
- Selecting investments for portfolio
diversification - Selecting investments for appropriate sector
representation
3Why Quantify Correlation
- Determine the strength of correlation
- Rank investments based on correlation strength
- Select most appropriate investments
4The Raw Data
5Time-Series Charts
- Show the data in sequence
- Easy to understand and interpret
- May indicate type of correlation
6Kelver versus VennesTime-series Chart
7Scatter Diagrams
- Readily show type of correlation
- Indicate strength of correlation
- Easily accommodate data at different levels
8Kelver versus VennesScatter Diagram
9Positive Correlation
- Data are plotted around a line that is sloped
upward to the right (positive slope) - The closer to the line the data plots are, the
stronger is the correlation
10Kelver versus GosvinTime-Series Chart
11Kelver versus GosvinScatter Diagram
12Negative Correlation
- Data are plotted around a line that is sloped
downward to the right (negative slope) - The closer the data plots are to the line, the
stronger is the correlation
13Maglin versus SelforTime-Series Chart
14Maglin versus SelforScatter Diagram
15Maglin versus SelforScatter Diagram
16Uncorrelated data
- Data plots are widely spread
- We may draw a line that may be sloped upward or
downward to the right, or with no slope at all - Since data are so spread out, the correlation is
weak
17Tallem versus SelforTime-Series Chart
18Tallem versus SelforScatter Diagram
19Correlation coefficient
20Positive Correlation
I
III
II
42.67
21Negative Correlation
40.58
42.67
22No (or low) Correlation
40.58
42.75
23Quantifying Correlation
- If there is perfect, positive correlation, the
correlation coefficients value is 1 - If there is perfect, negative correlation, the
correlation coefficients value is 1 - If there is no correlation, the correlation
coefficients value is 0
24Correlation 6 Stocks
25Correlation 6 Stocks
26Required Correlation
When is there enough correlation to say that
there is a linear relationship?
General Rule of Thumb - a linear relationship
exists if
i.e. no linear relationship between Tallem and
Selfor, since rxy 0.5265 lt
27Correlation in Excel
28Correlation in Excel
29Correlation in Excel
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30Correlation in Excel
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31Correlation in Excel
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32Correlation in Excel
33Correlation in Excel
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34Correlation in Excel
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35Correlation in Excel
the correlation coefficient for Kelver and Vennes
36The End Thank you for your attention