...

if we have information on more than one variables, we might be interested in seeing if

there is any connection - any association - between them.

4.1 INTRODUCTION
Statistical methods of measures of central tendency, dispersion, skewness and kurtosis are

helpful for the purpose of comparison and analysis of distributions involving only one

variable i.e. univariate distributions. However, describing the relationship between two or

more variables, is another important part of statistics.

In many business research situations, the key to decision making lies in understanding the

relationships between two or more variables. For example, in an effort to predict the behavior

of the bond market, a broker might find it useful to know whether the interest rate of bonds is

related to the prime interest rate. While studying the effect of advertising on sales, an account

executive may find it useful to know whether there is a strong relationship between

advertising dollars and sales dollars for a company.

The statistical methods of Correlation (discussed in the present lesson) and Regression (to be

discussed in the next lesson) are helpful in knowing the relationship between two or more

variables which may be related in same way, like interest rate of bonds and prime interest

rate; advertising expenditure and sales; income and consumption; crop-yield and fertilizer

used; height and weights and so on.

In all these cases involving two or more variables, we may be interested in seeing:

¾ if there is any association between the variables;

¾ if there is an association, is it strong enough to be useful;

¾ if so, what form the relationship between the two variables takes;

¾ how we can make use of that relationship for predictive purposes, that is, forecasting;

and

¾ how good such predictions will be.

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 Since these issues are inter related, correlation and regression analysis, as two sides of a

single process, consists of methods of examining the relationship between two or more

variables. If two (or more) variables are correlated, we can use information about one (or

more) variable(s) to predict the value of the other variable(s), and can measure the error

of estimations - a job of regression analysis.

4.2 WHAT IS CORRELATION?

Correlation is a measure of association between two or more variables. When two or more

variables very in sympathy so that movement in one tends to be accompanied by

corresponding movements in the other variable(s), they are said to be correlated.

“The correlation between variables is a measure of the nature and degree of

association between the variables”.

As a measure of the degree of relatedness of two variables, correlation is widely used in

exploratory research when the objective is to locate variables that might be related in some

way to the variable of interest.

4.2.1 TYPES OF CORRELATION

Correlation can be classified in several ways. The important ways of classifying correlation

are:

(i) Positive and negative,

(ii) Linear and non-linear (curvilinear) and

(iii) Simple, partial and multiple.

Positive and Negative Correlation

If both the variables move in the same direction, we say that there is a positive correlation,

i.e., if one variable increases, the other variable also increases on an average or if one variable

decreases, the other variable also decreases on an average.

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On the other hand, if the variables are varying in opposite direction, we say that it is a case of

negative correlation; e.g., movements of demand and supply.

Linear and Non-linear (Curvilinear) Correlation

If the change in one variable is accompanied by change in another variable in a constant ratio,

it is a case of linear correlation. Observe the following data:

X : 10 20 30 40 50
Y : 25 50 75 100 125

The ratio of change in the above example is the same. It is, thus, a case of linear correlation.

If we plot these variables on graph paper, all the points will fall on the same straight line.

On the other hand, if the amount of change in one variable does not follow a constant ratio

with the change in another variable, it is a case of non-linear or curvilinear correlation. If a

couple of figures in either series X or series Y are changed, it would give a non-linear

correlation.

Simple, Partial and Multiple Correlation

The distinction amongst these three types of correlation depends upon the number of

variables involved in a study. If only two variables are involved in a study, then the

correlation is said to be simple correlation. When three or more variables are involved in a

study, then it is a problem of either partial or multiple correlation. In multiple correlation,

three or more variables are studied simultaneously. But in partial correlation we consider only

two variables influencing each other while the effect of other variable(s) is held constant.

Suppose we have a problem comprising three variables X, Y and Z. X is the number of hours

studied, Y is I.Q. and Z is the number of marks obtained in the examination. In a multiple

correlation, we will study the relationship between the marks obtained (Z) and the two

variables, number of hours studied (X) and I.Q. (Y). In contrast, when we study the

98
relationship between X and Z, keeping an average I.Q. (Y) as constant, it is said to be a study

involving partial correlation.

In this lesson, we will study linear correlation between two variables.

4.2.2 CORRELATION DOES NOT NECESSARILY MEAN CAUSATION

The correlation analysis, in discovering the nature and degree of relationship between

variables, does not necessarily imply any cause and effect relationship between the variables.

Two variables may be related to each other but this does not mean that one variable causes

the other. For example, we may find that logical reasoning and creativity are correlated, but

that does not mean if we could increase peoples’ logical reasoning ability, we would produce

greater creativity. We need to conduct an actual experiment to unequivocally demonstrate a

causal relationship. But if it is true that influencing someones’ logical reasoning ability does

influence their creativity, then the two variables must be correlated with each other. In other

words, causation always implies correlation, however converse is not true.

Let us see some situations-

1. The correlation may be due to chance particularly when the data pertain to a small

sample. A small sample bivariate series may show the relationship but such a

relationship may not exist in the universe.

2. It is possible that both the variables are influenced by one or more other variables.

For example, expenditure on food and entertainment for a given number of

households show a positive relationship because both have increased over time.

But, this is due to rise in family incomes over the same period. In other words, the

two variables have been influenced by another variable - increase in family

incomes.

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 3. There may be another situation where both the variables may be influencing each

other so that we cannot say which is the cause and which is the effect. For

example, take the case of price and demand. The rise in price of a commodity may

lead to a decline in the demand for it. Here, price is the cause and the demand is

the effect. In yet another situation, an increase in demand may lead to a rise in

price. Here, the demand is the cause while price is the effect, which is just the

reverse of the earlier situation. In such situations, it is difficult to identify which

variable is causing the effect on which variable, as both are influencing each

other.

The foregoing discussion clearly shows that correlation does not indicate any causation or

functional relationship. Correlation coefficient is merely a mathematical relationship and

this has nothing to do with cause and effect relation. It only reveals co-variation between

two variables. Even when there is no cause-and-effect relationship in bivariate series and one

interprets the relationship as causal, such a correlation is called spurious or non-sense

correlation. Obviously, this will be misleading. As such, one has to be very careful in

correlation exercises and look into other relevant factors before concluding a cause-and-effect

relationship.

4.3 CORRELATION ANALYSIS

Correlation Analysis is a statistical technique used to indicate the nature and degree of

relationship existing between one variable and the other(s). It is also used along with

regression analysis to measure how well the regression line explains the variations of the

dependent variable with the independent variable.

The commonly used methods for studying linear relationship between two variables involve
both graphic and algebraic methods. Some of the widely used methods include:
1. Scatter Diagram

2. Correlation Graph

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 3. Pearson’s Coefficient of Correlation

4. Spearman’s Rank Correlation

5. Concurrent Deviation Method

4.3.1 SCATTER DIAGRAM

This method is also known as Dotogram or Dot diagram. Scatter diagram is one of the

simplest methods of diagrammatic representation of a bivariate distribution. Under this

method, both the variables are plotted on the graph paper by putting dots. The diagram so

obtained is called "Scatter Diagram". By studying diagram, we can have rough idea about the

nature and degree of relationship between two variables. The term scatter refers to the

spreading of dots on the graph. We should keep the following points in mind while

interpreting correlation:

¾ if the plotted points are very close to each other, it indicates high degree of

correlation. If the plotted points are away from each other, it indicates low degree of

correlation.

101
 Figure 4-1 Scatter Diagrams

¾ if the points on the diagram reveal any trend (either upward or downward), the

variables are said to be correlated and if no trend is revealed, the variables are

uncorrelated.

¾ if there is an upward trend rising from lower left hand corner and going upward to the

upper right hand corner, the correlation is positive since this reveals that the values of

the two variables move in the same direction. If, on the other hand, the points depict a

downward trend from the upper left hand corner to the lower right hand corner, the

correlation is negative since in this case the values of the two variables move in the

opposite directions.

¾ in particular, if all the points lie on a straight line starting from the left bottom and

going up towards the right top, the correlation is perfect and positive, and if all the

points like on a straight line starting from left top and coming down to right bottom,

the correlation is perfect and negative.

The various diagrams of the scattered data in Figure 4-1 depict different forms of correlation.

Example 4-1

102
Given the following data on sales (in thousand units) and expenses (in thousand rupees) of a

firm for 10 month:

Month : J F M A M J J A S O
Sales: 50 50 55 60 62 65 68 60 60 50
Expenses: 11 13 14 16 16 15 15 14 13 13
a) Make a Scatter Diagram

b) Do you think that there is a correlation between sales and expenses of the

firm? Is it positive or negative? Is it high or low?

Solution:(a) The Scatter Diagram of the given data is shown in Figure 4-2

20

15
Expenses

10

0
0 20 40 60 80
Sales

Figure 4.2 Scatter Diagram

(b) Figure 4-2 shows that the plotted points are close to each other and reveal an upward

trend. So there is a high degree of positive correlation between sales and expenses of the firm.

4.3.2 CORRELATION GRAPH

This method, also known as Correlogram is very simple. The data pertaining to two series are

plotted on a graph sheet. We can find out the correlation by examining the direction and

closeness of two curves. If both the curves drawn on the graph are moving in the same

direction, it is a case of positive correlation. On the other hand, if both the curves are moving

in opposite direction, correlation is said to be negative. If the graph does not show any

definite pattern on account of erratic fluctuations in the curves, then it shows an absence of

correlation.

103
Example 4-2
Find out graphically, if there is any correlation between price yield per plot (qtls); denoted by

Y and quantity of fertilizer used (kg); denote by X.

Plot No.: 1 2 3 4 5 6 7 8 9 10
Y: 3.5 4.3 5.2 5.8 6.4 7.3 7.2 7.5 7.8 8.3

X: 6 8 9 12 10 15 17 20 18 24

Solution: The Correlogram of the given data is shown in Figure 4-3

30
25
20
X and Y

15
10
5
0
1 2 3 4 5 6 7 8 9 10
Plot Number

Figure 4-3 Correlation Graph

Figure 4-3 shows that the two curves move in the same direction and, moreover, they are very

close to each other, suggesting a close relationship between price yield per plot (qtls) and

quantity of fertilizer used (kg)

Remark: Both the Graphic methods - scatter diagram and correlation graph provide a

‘feel for’ of the data – by providing visual representation of the association between the

variables. These are readily comprehensible and enable us to form a fairly good, though

rough idea of the nature and degree of the relationship between the two variables. However,

these methods are unable to quantify the relationship between them. To quantify the extent of

correlation, we make use of algebraic methods - which calculate correlation coefficient.

4.3.3 PEARSON’S COEFFICIENT OF CORRELATION

A mathematical method for measuring the intensity or the magnitude of linear relationship

104
between two variables was suggested by Karl Pearson (1867-1936), a great British

Biometrician and Statistician and, it is by far the most widely used method in practice.

Karl Pearson’s measure, known as Pearsonian correlation coefficient between two variables X

and Y, usually denoted by r(X,Y) or rxy or simply r is a numerical measure of linear

relationship between them and is defined as the ratio of the covariance between X and Y, to

the product of the standard deviations of X and Y.

Symbolically

Cov ( X , Y )
rxy = …………(4.1)
S x .S y

when, ( X 1 , Y1 ); ( X 2 , Y2 );..................( X n , Yn ) are N pairs of observations of the variables X and

Y in a bivariate distribution,

Cov( X , Y ) =
∑ ( X − X )(Y − Y ) …………(4.2a)
N

Sx =
∑(X − X ) 2

…………(4.2b)
N

and Sy =
∑ (Y − Y ) 2

…………(4.2c)
N

Thus by substituting Eqs. (4.2) in Eq. (4.1), we can write the Pearsonian correlation
coefficient as
1
N
∑ ( X − X )(Y − Y )
rxy =
1 1
N
∑(X − X ) 2

N
∑ (Y − Y ) 2

rxy =
∑ ( X − X )(Y − Y ) …………(4.3)
∑ ( X − X ) ∑ (Y − Y )
2 2

105
If we denote, d x = X − X and d y = Y − Y

Then rxy =
∑d x dy
…………(4.3a)
∑d
2 2
x dy

We can further simply the calculations of Eqs. (4.2)

We have

1
Cov( X , Y ) =
N
∑ ( X − X )(Y − Y )
1
=
N
∑ XY − X Y
1 ∑ X ∑Y
=
N
∑ XY − N N

=
1
N2
[
N ∑ XY − ∑ X ∑ Y ] …………(4.4)

1
and S x2 =
N
∑(X − X ) 2

1
=
N
∑X 2
−( X ) 2

⎛∑X
2
1 ⎞
=
N
∑ X −⎜⎜ N 2 ⎟
⎟
⎝ ⎠

=
N
1
2
[
N ∑ X 2 − (∑ X )
2
] …………(4.5a)

Similarly, we have

S y2 =
N
1
2
[
N ∑ Y 2 − (∑ Y )
2
] …………(4.5b)

So Pearsonian correlation coefficient may be found as

1
N2
N ∑ XY − ∑ X ∑ Y [ ]
rxy =

N
1
2
[
N ∑ X 2 − (∑ X )
2

N
1
2
N ∑ Y 2 − (∑ Y )
2
] [ ]

N ∑ XY − ∑ X ∑ Y
or rxy = …………(4.6)
N ∑ X − (∑ X ) N ∑ Y − (∑ Y )
2 2 2 2

106
Remark: Eq. (4.3) or Eq. (4.3a) is quite convenient to apply if the means X and

Y come out to be integers. If X or/and Y is (are) fractional then the Eq. (4.3) or Eq. (4.3a) is

quite cumbersome to apply, since the computations of ∑(X − X ) 2

, ∑ (Y − Y ) 2
and

∑ ( X − X )(Y − Y ) are quite time consuming and tedious. In such a case Eq. (4.6) may be

used provided the values of X or/ and Y are small. But if X and Y assume large values, the

calculation of ∑ X , ∑Y
2 2
and ∑ XY is again quite time consuming.

Thus if (i) X and Y are fractional and (ii) X and Y assume large values, the Eq. (4.3) and Eq.

(4.6) are not generally used for numerical problems. In such cases, the step deviation method

where we take the deviations of the variables X and Y from any arbitrary points is used. We

will discuss this method in the properties of correlation coefficient.

4.3.3.1 Properties of Pearsonian Correlation Coefficient

The following are important properties of Pearsonian correlation coefficient:

1. Pearsonian correlation coefficient cannot exceed 1 numerically. In other words it lies

between –1 and +1. Symbolically,

-1 ≤ r ≤1

Remarks: (i) This property provides us a check on our calculations. If in any problem,

the obtained value of r lies outside the limits + 1, this implies that there is some mistake in

our calculations.

(ii) The sign of r indicate the nature of the correlation. Positive value of r indicates

positive correlation, whereas negative value indicates negative correlation. r = 0 indicate

absence of correlation.

(iii) The following table sums up the degrees of correlation corresponding to various

values of r:

107
 Value of r Degree of correlation
±1 perfect correlation
±0.90 or more very high degree of correlation
sufficiently high degree of
±0.75 to ±0.90
correlation
±0.60 to ±0.75 moderate degree of correlation
only the possibility of a
±0.30 to ±0.60
correlation
less than ±0.30 possibly no correlation
0 absence of correlation

2. Pearsonian Correlation coefficient is independent of the change of origin and scale.

Mathematically, if given variables X and Y are transformed to new variables U and V

by change of origin and scale, i. e.

X−A Y −B
U= and V =
h k

Where A, B, h and k are constants and h > 0, k > 0; then the correlation coefficient

between X and Y is same as the correlation coefficient between U and V i.e.,

r(X,Y) = r(U, V) => rxy = ruv

Remark: This is one of the very important properties of the correlation coefficient and

is extremely helpful in numerical computation of r. We had already stated that Eq. (4.3) and

Eq.(4.6) become quite tedious to use in numerical problems if X and/or Y are in fractions or if

X and Y are large. In such cases we can conveniently change the origin and scale (if possible)

in X or/and Y to get new variables U and V and compute the correlation between U and V by

the Eq. (4.7)

N ∑ UV − ∑ U ∑ V
rxy = ruv = …………(4.7)
N ∑ U − (∑ U ) N ∑ V − (V )
2 2 2 2

3. Two independent variables are uncorrelated but the converse is not true

108
 If X and Y are independent variables then

rxy = 0

However, the converse of the theorem is not true i.e., uncorrelated variables need not

necessarily be independent. As an illustration consider the following bivariate

distribution.

X : 1 2 3 -3 -2 -1
Y : 1 4 9 9 4 1

For this distribution, value of r will be 0.

Hence in the above example the variable X and Y are uncorrelated. But if we examine

the data carefully we find that X and Y are not independent but are connected by the

relation Y = X2. The above example illustrates that uncorrelated variables need not be

independent.

Remarks: One should not be confused with the words uncorrelation and independence.

rxy = 0 i.e., uncorrelation between the variables X and Y simply implies the absence of any

linear (straight line) relationship between them. They may, however, be related in some other

form other than straight line e.g., quadratic (as we have seen in the above example),

logarithmic or trigonometric form.

4. Pearsonian coefficient of correlation is the geometric mean of the two regression

coefficients, i.e.

rxy = ± bxy .b yx

The signs of both the regression coefficients are the same, and so the value of r will

also have the same sign.

This property will be dealt with in detail in the next lesson on Regression Analysis.

109
 5. The square of Pearsonian correlation coefficient is known as the coefficient of

determination.

Coefficient of determination, which measures the percentage variation in the

dependent variable that is accounted for by the independent variable, is a much better

and useful measure for interpreting the value of r. This property will also be dealt

with in detail in the next lesson.

4.3.3.2 Probable Error of Correlation Coefficient

The correlation coefficient establishes the relationship of the two variables. After ascertaining

this level of relationship, we may be interested to find the extent upto which this coefficient is

dependable. Probable error of the correlation coefficient is such a measure of testing the

reliability of the observed value of the correlation coefficient, when we consider it as

satisfying the conditions of the random sampling.

If r is the observed value of the correlation coefficient in a sample of N pairs of observations

for the two variables under consideration, then the Probable Error, denoted by PE (r) is

expressed as

PE (r ) = 0.6745 SE (r )

1− r2
or PE (r ) = 0.6745
N

There are two main functions of probable error:

1. Determination of limits: The limits of population correlation coefficient are r ±

PE(r), implying that if we take another random sample of the size N from the same

population, then the observed value of the correlation coefficient in the second

sample can be expected to lie within the limits given above, with 0.5 probability.

When sample size N is small, the concept or value of PE may lead to wrong

110
 conclusions. Hence to use the concept of PE effectively, sample size N it should be

fairly large.

2. Interpretation of 'r': The interpretation of 'r' based on PE is as under:

¾ If r < PE(r), there is no evidence of correlation, i.e. a case of insignificant

correlation.

¾ If r > 6 PE(r), correlation is significant. If r < 6 PE(r), it is insignificant.

¾ If the probable error is small, correlation exist where r > 0.5

Example 4-3
Find the Pearsonian correlation coefficient between sales (in thousand units) and expenses (in

thousand rupees) of the following 10 firms:

Firm: 1 2 3 4 5 6 7 8 9 10
Sales: 50 50 55 60 65 65 65 60 60 50
Expenses: 11 13 14 16 16 15 15 14 13 13

Solution: Let sales of a firm be denoted by X and expenses be denoted by Y

Calculations for Coefficient of Correlation

{Using Eq. (4.3) or (4.3a)}

Firm X Y dx =X−X dy =Y −Y d x2 d y2 dx.dy

1 50 11 -8 -3 64 9 24
2 50 13 -8 -1 64 1 8
3 55 14 -3 0 9 0 0
4 60 16 2 2 4 4 4
5 65 16 7 2 49 4 14
6 65 15 7 1 49 1 7
7 65 15 7 1 49 1 7
8 60 14 2 0 4 0 0
9 60 13 2 -1 4 1 -2
10 50 13 -8 -1 64 1 8

∑ X ∑Y ∑d
2
x ∑d
2
y
∑d x dy

111
 = = =360 =22 =70
580 140

X=
∑X = 580
= 58 and Y=
∑ Y = 140 = 14
N 10 N 10

Applying the Eq. (4.3a), we have, Pearsonian coefficient of correlation

rxy =
∑d x dy

∑d
2 2
x dy
70
rxy =
360 x 22
70
rxy =
7920
rxy = 0.78
The value of rxy = 0.78 , indicate a high degree of positive correlation between sales and expenses.
Example 4-4
The data on price and quantity purchased relating to a commodity for 5 months is given

below:

Month : January February March April May

Prices(Rs): 10 10 11 12 12
Quantity(Kg): 5 6 4 3 3

Find the Pearsonian correlation coefficient between prices and quantity and comment on its

sign and magnitude.

Solution: Let price of the commodity be denoted by X and quantity be denoted by Y

Calculations for Coefficient of Correlation

{Using Eq. (4.6)}
Month X Y X2 Y2 XY
1 10 5 100 25 50
2 10 6 100 36 60
3 11 4 121 16 44
4 12 3 144 9 36
5 12 3 144 9 36

112
 ∑X =55 ∑ Y =21 ∑X 2
= 609 ∑Y 2
= 95 ∑ XY = 226

Applying the Eq. (4.6), we have, Pearsonian coefficient of correlation

N ∑ XY − ∑ X ∑ Y
rxy =
N ∑ X 2 − (∑ X ) N ∑ Y 2 − (∑ Y )
2 2

5 x 226 − 55 x 21
rxy =
(5 x609 − 55 x55)(5 x95 − 21x 21)

1130 − 1155
rxy =
20 x34

− 25
rxy =
680

rxy = −0.98

The negative sign of r indicate negative correlation and its large magnitude indicate a very

high degree of correlation. So there is a high degree of negative correlation between prices

and quantity demanded.

Example 4-5
Find the Pearsonian correlation coefficient from the following series of marks obtained by 10

students in a class test in mathematics (X) and in Statistics (Y):

X: 45 70 65 30 90 40 50 75 85 60
Y: 35 90 70 40 95 40 60 80 80 50

Also calculate the Probable Error.

Solution:
Calculations for Coefficient of Correlation
{Using Eq. (4.7)}
X Y U V U2 V2 UV
45 35 -3 -6 9 36 18
70 90 2 5 4 25 10
65 70 1 1 1 1 1

113
 30 40 -6 -5 36 25 30
90 95 6 6 36 36 36
40 40 -4 -5 16 25 20
50 60 -2 -1 4 1 2
75 80 3 3 9 9 9
85 80 5 3 25 9 15
60 50 0 -3 0 9 0
∑U = 2 ∑V = −2 ∑U 2
= 140 ∑V 2
= 176 ∑UV = 141

We have, defined variables U and V as

X − 60 Y − 65
U= and V=
5 5

Applying the Eq. (4.7)

N ∑ UV − (∑ U ∑ V )
rxy = ruv =
N ∑ U 2 − (∑ U ) N ∑ V 2 − (∑ V )
2 2

10 x141 − 2 x(−2)
=
10 x140 − 2 x 2 10 x176 − (−2) x(−2)

1410 + 4
=
1400 − 4 1760 − 4

1414
=
2451376

= 0.9

So there is a high degree of positive correlation between marks obtained in Mathematics and

in Statistics.

Probable Error, denoted by PE (r) is given as

1− r2
PE (r ) = 0.6745
N

114
 1 − (0.9 )
2
PE (r ) = 0.6745
10

PE (r ) = 0.0405

So the value of r is highly significant.

4.3.4 SPEARMAN’S RANK CORRELATION

Sometimes we come across statistical series in which the variables under consideration are

not capable of quantitative measurement but can be arranged in serial order. This happens

when we are dealing with qualitative characteristics (attributes) such as honesty, beauty,

character, morality, etc., which cannot be measured quantitatively but can be arranged

serially. In such situations Karl Pearson’s coefficient of correlation cannot be used as such.

Charles Edward Spearman, a British Psychologist, developed a formula in 1904, which

consists in obtaining the correlation coefficient between the ranks of N individuals in the two

attributes under study.

Suppose we want to find if two characteristics A, say, intelligence and B, say, beauty are

related or not. Both the characteristics are incapable of quantitative measurements but we can

arrange a group of N individuals in order of merit (ranks) w.r.t. proficiency in the two

characteristics. Let the random variables X and Y denote the ranks of the individuals in the

characteristics A and B respectively. If we assume that there is no tie, i.e., if no two

individuals get the same rank in a characteristic then, obviously, X and Y assume numerical

values ranging from 1 to N.

The Pearsonian correlation coefficient between the ranks X and Y is called the rank

correlation coefficient between the characteristics A and B for the group of individuals.

Spearman’s rank correlation coefficient, usually denoted by ρ(Rho) is given by the equation

6∑ d 2
ρ =1 − …………(4.8)
N ( N 2 − 1)

115
Where d is the difference between the pair of ranks of the same individual in the two

characteristics and N is the number of pairs.

Example 4-6
Ten entries are submitted for a competition. Three judges study each entry and list the ten in

rank order. Their rankings are as follows:

Entry: A B C D E F G H I J
Judge J1: 9 3 7 5 1 6 2 4 10 8
Judge J2: 9 1 10 4 3 8 5 2 7 6
Judge J3: 6 3 8 7 2 4 1 5 9 10

Calculate the appropriate rank correlation to help you answer the following questions:

(i) Which pair of judges agrees the most?

(ii) Which pair of judges disagrees the most?
Solution:
Calculations for Coefficient of Rank Correlation
{Using Eq.(4.8)}
Entry Rank by
Judges Difference in Ranks
J1 J2 J3 d(J1&J2) d2 d(J1&J3) d2 d(J2&J3) d2
A 9 9 6 0 0 +3 9 +3 9
B 3 1 3 +2 4 0 0 -2 4
C 7 10 8 -3 9 -1 1 +2 4
D 5 4 7 +1 1 -2 4 -3 9
E 1 3 2 -2 4 -1 1 +1 1
F 6 8 4 -2 4 +2 4 +4 16
G 2 5 1 -3 9 +1 1 +4 16
H 4 2 5 +2 4 -1 1 -3 9
I 10 7 9 +3 9 +1 1 -2 4
J 8 6 10 +2 4 -2 4 -4 16
∑d2 =48 ∑d2 =26 ∑d2 =88

6∑ d 2
ρ (J1 & J2) = 1 −
N ( N 2 − 1)

116
 6 x 48
=1 −
10(10 2 − 1)
288
=1 −
990
=1 – 0.29
= +0.71
6∑ d 2
ρ (J1 & J3) =1 −
N ( N 2 − 1)

6 x 26
=1 −
10(10 2 − 1)
156
=1 −
990
=1 – 0.1575
= +0.8425

6∑ d 2
ρ (J2 & J3) =1 −
N ( N 2 − 1)

6 x 88
=1 −
10(10 2 − 1)
528
=1 −
990
=1 – 0.53
= +0.47

So (i) Judges J1 and J3 agree the most

(ii) Judges J2 and J3 disagree the most

Spearman’s rank correlation Eq.(4.8) can also be used even if we are dealing with variables,

which are measured quantitatively, i.e. when the actual data but not the ranks relating to two

variables are given. In such a case we shall have to convert the data into ranks. The highest

(or the smallest) observation is given the rank 1. The next highest (or the next lowest)

observation is given rank 2 and so on. It is immaterial in which way (descending or

ascending) the ranks are assigned. However, the same approach should be followed for all the

variables under consideration.

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Example 4-7
Calculate the rank coefficient of correlation from the following data:
X: 75 88 95 70 60 80 81 50
Y: 120 134 150 115 110 140 142 100

Solution:
Calculations for Coefficient of Rank Correlation
{Using Eq.(4.8)}
X Ranks RX Y Ranks RY d = RX -RY d2
75 5 120 5 0 0
88 2 134 4 -2 4
95 1 150 1 0 0
70 6 115 6 0 0
60 7 110 7 0 0
80 4 140 3 +1 1
81 3 142 2 +1 1
50 8 100 8 0 0
∑d2 = 6
6∑ d 2
ρ = 1−
N ( N 2 − 1)

6x6
= 1−
8(8 2 − 1)
36
= 1−
504
= 1 – 0.07
= + 0.93
Hence, there is a high degree of positive correlation between X and Y

Repeated Ranks

In case of attributes if there is a tie i.e., if any two or more individuals are placed together in

any classification w.r.t. an attribute or if in case of variable data there is more than one item

with the same value in either or both the series then Spearman’s Eq.(4.8) for calculating the

rank correlation coefficient breaks down, since in this case the variables X [the ranks of

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individuals in characteristic A (1st series)] and Y [the ranks of individuals in characteristic B

(2nd series)] do not take the values from 1 to N.

In this case common ranks are assigned to the repeated items. These common ranks are the

arithmetic mean of the ranks, which these items would have got if they were different from

each other and the next item will get the rank next to the rank used in computing the common

rank. For example, suppose an item is repeated at rank 4. Then the common rank to be

assigned to each item is (4+5)/2, i.e., 4.5 which is the average of 4 and 5, the ranks which

these observations would have assumed if they were different. The next item will be assigned

the rank 6. If an item is repeated thrice at rank 7, then the common rank to be assigned to

each value will be (7+8+9)/3, i.e., 8 which is the arithmetic mean of 7,8 and 9 viz., the ranks

these observations would have got if they were different from each other. The next rank to be

assigned will be 10.

If only a small proportion of the ranks are tied, this technique may be applied together with

Eq.(4.8). If a large proportion of ranks are tied, it is advisable to apply an adjustment or a

correction factor to Eq.(4.8)as explained below:

“In the Eq.(4.8) add the factor

m(m 2 − 1)
…………(4.8a)
12

∑d
2
to ; where m is the number of times an item is repeated. This correction factor is to be

added for each repeated value in both the series”.

Example 4-8
For a certain joint stock company, the prices of preference shares (X) and debentures (Y) are
given below:
X: 73.2 85.8 78.9 75.8 77.2 81.2 83.8
Y: 97.8 99.2 98.8 98.3 98.3 96.7 97.1

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 Use the method of rank correlation to determine the relationship between preference prices
and debentures prices.
Solution:
Calculations for Coefficient of Rank Correlation
{Using Eq. (4.8) and (4.8a)}
X Y Rank of X (XR) Rank of Y (YR) d = XR – YR d2
73.2 97.8 7 5 2 4
85.8 99.2 1 1 0 0
78.9 98.8 4 2 2 4
75.8 98.3 6 3.5 2.5 6.25
77.2 98.3 5 3.5 1.5 2.25
81.2 96.7 3 7 -4 16
83.8 97.1 2 6 -4 16

∑d = 0 ∑d
2
= 48.50

In this case, due to repeated values of Y, we have to apply ranking as average of 2 ranks,

which could have been allotted, if they were different values. Thus ranks 3 and 4 have been

allotted as 3.5 to both the values of Y = 98.3. Now we also have to apply correction factor

m(m 2 − 1)
∑d
2
to , where m in the number of times the value is repeated, here m = 2.
12

⎡
6 ⎢∑ d 2 +
(
m m2 −1 ⎤ )
⎥
⎣ 2 ⎦
ρ =
N ( N − 1)
2

⎡ 2(4 − 1) ⎤
6⎢48.5 +
⎣ 12 ⎥⎦
=
7(7 2 − 1)
6 x 49
= 1-
7 x 48
= 0.125
Hence, there is a very low degree of positive correlation, probably no correlation,

between preference share prices and debenture prices.

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Remarks on Spearman’s Rank Correlation Coefficient

1. We always have ∑ d = 0 , which provides a check for numerical calculations.

2. Since Spearman’s rank correlation coefficient, ρ, is nothing but Karl Pearson’s

correlation coefficient, r, between the ranks, it can be interpreted in the same way

as the Karl Pearson’s correlation coefficient.

3. Karl Pearson’s correlation coefficient assumes that the parent population from

which sample observations are drawn is normal. If this assumption is violated then

we need a measure, which is distribution free (or non-parametric). Spearman’s ρ

is such a distribution free measure, since no strict assumption are made about the

from of the population from which sample observations are drawn.

4. Spearman’s formula is easy to understand and apply as compared to Karl

Pearson’s formula. The values obtained by the two formulae, viz Pearsonian r and

Spearman’s ρ are generally different. The difference arises due to the fact that

when ranking is used instead of full set of observations, there is always some loss

of information. Unless many ties exist, the coefficient of rank correlation should

be only slightly lower than the Pearsonian coefficient.

5. Spearman’s formula is the only formula to be used for finding correlation

coefficient if we are dealing with qualitative characteristics, which cannot be

measured quantitatively but can be arranged serially. It can also be used where

actual data are given. In case of extreme observations, Spearman’s formula is

preferred to Pearson’s formula.

6. Spearman’s formula has its limitations also. It is not practicable in the case of

bivariate frequency distribution. For N >30, this formula should not be used unless

the ranks are given.

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4.3.5 CONCURRENT DEVIATION METHOD

This is a casual method of determining the correlation between two series when we are not

very serious about its precision. This is based on the signs of the deviations (i.e. the

direction of the change) of the values of the variable from its preceding value and does not

take into account the exact magnitude of the values of the variables. Thus we put a plus (+)

sign, minus (-) sign or equality (=) sign for the deviation if the value of the variable is greater

than, less than or equal to the preceding value respectively. The deviations in the values of

two variables are said to be concurrent if they have the same sign (either both deviations are

positive or both are negative or both are equal). The formula used for computing correlation

coefficient rc by this method is given by

⎛ 2c − N ⎞
rc = + +⎜ ⎟ …………(4.9)
⎝ N ⎠

Where c is the number of pairs of concurrent deviations and N is the number of pairs of

deviations. If (2c-N) is positive, we take positive sign in and outside the square root in Eq.

(4.9) and if (2c-N) is negative, we take negative sign in and outside the square root in Eq.

(4.9).

Remarks: (i) It should be clearly noted that here N is not the number of pairs of

observations but it is the number of pairs of deviations and as such it is one less than the

number of pairs of observations.

(ii) Coefficient of concurrent deviations is primarily based on the following

principle:

“If the short time fluctuations of the time series are positively correlated or in other
words, if their deviations are concurrent, their curves would move in the same
direction and would indicate positive correlation between them”
Example 4-9

122
 Calculate coefficient of correlation by the concurrent deviation method

Supply: 112 125 126 118 118 121 125 125 131 135
Price: 106 102 102 104 98 96 97 97 95 90

Solution:
Calculations for Coefficient of Concurrent Deviations
{Using Eq. (4.9)}
Supply Sign of deviation from Price Sign of deviation Concurrent
(X) preceding value (X) (Y) preceding value (Y) deviations
112 106
125 + 102 -
126 + 102 =
118 - 104 +
118 = 98 -
121 + 96 -
125 + 97 + +(c)
125 = 97 = = ( c)
131 + 95 -
135 + 90 -

We have
Number of pairs of deviations, N =10 – 1 = 9
c = Number of concurrent deviations
= Number of deviations having like signs
=2
Coefficient of correlation by the method of concurrent deviations is given by:

⎛ 2c − N ⎞
rc = + +⎜ ⎟
⎝ N ⎠

⎛ 2x 2 − 9 ⎞
rc = + +⎜ ⎟
⎝ 9 ⎠

rc = + +(− 0.5556 )
Since 2c – N = -5 (negative), we take negative sign inside and outside the square root

123
 rc = − − (− 0.5556 )

rc = − 0.5556

rc = −0.7
Hence there is a fairly good degree of negative correlation between supply and price.

4.4 LIMITATIONS OF CORRELATION ANALYSIS

As mentioned earlier, correlation analysis is a statistical tool, which should be properly used

so that correct results can be obtained. Sometimes, it is indiscriminately used by

management, resulting in misleading conclusions. We give below some errors frequently

made in the use of correlation analysis:

1. Correlation analysis cannot determine cause-and-effect relationship. One should not

assume that a change in Y variable is caused by a change in X variable unless one is

reasonably sure that one variable is the cause while the other is the effect. Let us take

an example. .

Suppose that we study the performance of students in their graduate examination and

their earnings after, say, three years of their graduation. We may find that these two

variables are highly and positively related. At the same time, we must not forget that

both the variables might have been influenced by some other factors such as quality of

teachers, economic and social status of parents, effectiveness of the interviewing

process and so forth. If the data on these factors are available, then it is worthwhile to

use multiple correlation analysis instead of bivariate one.

2. Another mistake that occurs frequently is on account of misinterpretation of the

coefficient of correlation. Suppose in one case r = 0.7, it will be wrong to interpret

that correlation explains 70 percent of the total variation in Y. The error can be seen

easily when we calculate the coefficient of determination. Here, the coefficient of

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 determination r2 will be 0.49. This means that only 49 percent of the total variation in

Y is explained.

Similarly, the coefficient of determination is misinterpreted if it is also used to

indicate causal relationship, that is, the percentage of the change in one variable is due

to the change in another variable.

3. Another mistake in the interpretation of the coefficient of correlation occurs when one

concludes a positive or negative relationship even though the two variables are

actually unrelated. For example, the age of students and their score in the examination

have no relation with each other. The two variables may show similar movements but

there does not seem to be a common link between them.

To sum up, one has to be extremely careful while interpreting coefficient of correlation. Be-

fore one concludes a causal relationship, one has to consider other relevant factors that might

have any influence on the dependent variable or on both the variables. Such an approach will

avoid many of the pitfalls in the interpretation of the coefficient of correlation. It has been

rightly said that the coefficient of correlation is not only one of the most widely used, but

also one of the widely abused statistical measures.

4.5 SELF-ASSESSMENT QUESTIONS

1. “Correlation and Regression are two sides of the same coin”. Explain.

2. Explain the meaning and significance of the concept of correlation. Does correlation

always signify casual relationships between two variables? Explain with illustration

on what basis can the following correlation be criticized?

(a) Over a period of time there has been an increased financial aid to under

developed countries and also an increase in comedy act television shows. The

correlation is almost perfect.

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