portfolio performance measurement, attribution and reporting, portfolio management models

2. Correlation
• Statistical technique which tells us if two
variables are related.
• It is used to understand:
1. whether the relationship is positive or
negative
2. the strength of relationship.

3. Coefficient of Correlation
• Statistical correlation is measured by what is
called coefficient of correlation (r).
• Its numerical value ranges from +1.0 to -1.0. It
gives us an indication of the strength of
relationship.

4. • In general, r > 0 indicates positive relationship,
r < 0 indicates negative relationship
• while r = 0 indicates no relationship (or that
the variables are independent and not
related).
• Here r = +1.0 describes a perfect positive
correlation and r = -1.0 describes a perfect
negative correlation.

6. As a rule of thumb, the following
guidelines on strength of relationship are
often useful
Value of r Strength of relationship
-1 to - 0.5 Strong negative relationship
-0.5 to - 0.3 Moderate negative relationship
-0.3 to -0.1 Weak negative relationship
-0.1 to 0.1 No relationship
0.1 to 0.3 Weak positive relationship
0.3 to 0.5 Moderate positive relationship
0.5 to 1 Strong positive relationship

7. • Correlation is only appropriate for examining
the relationship between meaningful
quantifiable data (e.g. stock / portfolio return,
air pressure, temperature) rather than
categorical data such as gender, favorite color
etc.

8. • Statistical correlation should not be the
primary tool used to study causation, because
of the problem with third variables.

11. Coefficient of Correlation
Stock Returns
Portfolio
Retun
Market
Return
Year ONGC HPCL BPCL
Nifty Energy
Index
2007 8 1 15 8 8
2008 9 2 11 7 9
2009 10 9 2 7 10
2010 11 3 15 10 11
2011 12 4 3 6 12
2012 13 6 18 12 13
2013 14 8 -4 6 14
2014 15 3 1 6 15
2015 16 2 1 6 16
1016 18 4 18 13 18