Correlation
Correlation measures the degree to which two securities move in relation to each other, ranging from -1 (perfect negative) to +1 (perfect positive).
Concept map
Learn, apply, review
Definition
Correlation measures the degree to which two securities move in relation to each other, ranging from -1 (perfect negative) to +1 (perfect positive).
Use case
Used in portfolio management workflows, analysis, and technical interviews.
Judgment check
Useful only when the assumptions and inputs behind the metric are understood.
Deep dive
How to think about Correlation
Correlation is crucial for diversification — combining low or negatively correlated assets reduces portfolio risk without sacrificing expected return. Correlations are unstable, often increasing toward 1 during market stress when diversification is needed most. Historical correlations may not predict future relationships.
Example: Stocks and bonds historically have 0.0-0.3 correlation, making them good diversifiers. But in March 2020, correlation spiked as both sold off in a liquidity crisis. Safe-haven assets like US Treasuries and gold typically have negative correlation with equities during stress.
Rank-ready answer
Definition, example, and interview framing
Correlation measures the degree to which two securities move in relation to each other, ranging from -1 (perfect negative) to +1 (perfect positive).
Stocks and bonds historically have 0.0-0.3 correlation, making them good diversifiers. But in March 2020, correlation spiked as both sold off in a liquidity crisis. Safe-haven assets like US Treasuries and gold typically have negative correlation with equities during stress.
In an interview, define Correlation, explain where it appears in a real finance workflow, then name one assumption or limitation that a reviewer should check.
FAQ
Frequently Asked Questions
What is Correlation?
Correlation measures the degree to which two securities move in relation to each other, ranging from -1 (perfect negative) to +1 (perfect positive).
How is Correlation used in finance?
Correlation is crucial for diversification — combining low or negatively correlated assets reduces portfolio risk without sacrificing expected return. Correlations are unstable, often increasing toward 1 during market stress when diversification is needed most. Historical correlations may not predict future relationships.
Can you give an example of Correlation?
Stocks and bonds historically have 0.0-0.3 correlation, making them good diversifiers. But in March 2020, correlation spiked as both sold off in a liquidity crisis. Safe-haven assets like US Treasuries and gold typically have negative correlation with equities during stress.