Tuesday, 19 July 2022

Covariance and Correlation

Scatter Plot

- Direction

• If it’s upward = positive = Direct relationship

• If it’s outward = negative = Inverse relationship

- Strength

• More closer each dots with each other, more related, stronger

• Less closer each dots with each other, less related, weaker

- Linear = Straight line

- Non-linear = Curve

Covariance

- To interpret the direction of relationship (not the strength)

- Can be manipulated

- Dependent (a ected by scale of variable, ex: 10 converted to 1000 dollars)

- (s) Sample : n-1

- (α) Population : n

Correlation

- more useful because its sign will be useful to determine the relationship and the
value of correlation (correlation coe cient) is useful

- number will tell the strength

0,5 to 0,6 is
- sign will tell the relationship
moderate
- non linear mean Correlation equal to 0

-1 0 0.5 1
Strong
- 0,5 to - 0,6 is Relatively weak
moderate

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- Correl = COV (X,Y)/SxSy

- X is big, Y is also predictably big

Regression

- regression will help with making forecast

- Multiple R (Correlation coe cient)

- Will always be absolute value = always positive

- Therefore, it can be misleading

- However size of slope will tell the positive or negative

- Population = all New York income earners, all Australians, all countries, all rms,
etc.)

- Yi = β0 + β1Xi + ei

- Sample = non-representative sample would be one where we select a few rms in

a particular industry rather than a representative sample of all industries

- Yˆi = βˆ0 + βˆ1Xi + eˆi

- Bo is intercept

- B1 is slope

- the βˆ’s will be our estimates of them—this includes eˆi which is our estimate
of the error.

- The true population value was μ and our estimate, the mean, was denoted X ̄.

- The slope of the line tells us how much Y would change (and in what
direction) if X were one unit larger.

Dependent

Independent

- Example = Y = −42933 + 5247X .

perception Slope

- The slope of 5247 tells us that if someone were to do one more year of
education, their income would be $5,247 higher on average.

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 - Income is dependent, Education is independent

- other way : their income will increase than $5,247

- The main reason of the equation : to predict the forecast to estimate

- How to count regression in excel

- Data

- select ‘Data Analysis’ (this should be at the far right)

- select ‘Regression’.

Note

When we look through investment portfolio:

- Return = Mean (average)

- Risk = standard deviation (measure of dispersion) or Correlation variation

- We use CV more in risk because we may have di erent mean, thus for fairer equation

- CV =StD/Mean x 100

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