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Session 5 - Corelation Coefficient

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22 views3 pages

Session 5 - Corelation Coefficient

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Ningreipam Rungsung
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Sesssion-5

Correlation coefficient

What Is the Correlation Coefficient?


The correlation coefficient is a statistical measure of the strength of the relationship between the
relative movements of two variables. The values range between -1.0 and 1.0. A calculated
number greater than 1.0 or less than -1.0 means that there was an error in the correlation
measurement. A correlation of -1.0 shows a perfect negative correlation while a correlation of
1.0 shows a perfect positive correlation. A correlation of 0.0 shows no linear relationship
between the movements of the two variables.

Correlation statistics can be used in finance and investing. For example, a correlation coefficient
could be calculated to determine the level of correlation between the price of crude oil and the
stock price of an oil-producing company, such as Exxon Mobil Corporation. Since oil companies
earn greater profits as oil prices rise, the correlation between the two variables is highly positive.

There are several types of correlation coefficients, but the one that is most common is the
Pearson correlation (r). This measures the strength and direction of the linear
relationship between two variables. It cannot capture nonlinear relationships between two
variables and cannot differentiate between dependent and independent variables.

A value of exactly 1.0 means there is a perfect positive relationship between the two variables.
For a positive increase in one variable, there is also a positive increase in the second variable. A
value of -1.0 means there is a perfect negative relationship between the two variables. This
shows that the variables move in opposite directions - for a positive increase in one variable,
there is a decrease in the second variable. If the correlation between two variables is 0, there is
no linear relationship between them.

The strength of the relationship varies in degree based on the value of the correlation coefficient.
For example, a value of 0.2 shows there is a positive correlation between two variables, but it is
weak and likely unimportant. Analysts in some fields of study do not consider correlations
important until the value surpasses at least 0.8. However, a correlation coefficient with an
absolute value of 0.9 or greater would represent a very strong relationship.

Correlation Coefficient Equation


To calculate the Pearson product-moment correlation, one must first determine the covariance of
the two variables in question. Next, one must calculate each variable's standard deviation. The
correlation coefficient is determined by dividing the covariance by the product of the two
variables' standard deviations.

Standard deviation is a measure of the dispersion of data from its average. Covariance is a
measure of how two variables change together, but its magnitude is unbounded, so it is difficult
to interpret. By dividing covariance by the product of the two standard deviations, one can
calculate the normalized version of the statistic. This is the correlation coefficient.

Question

1. What is correlation?
2. Mention the types of correlation.
3. Mention different methods of calculation in correlation

Video link
https://www.youtube.com/watch?v=4EXNedimDMs

https://www.youtube.com/watch?v=lVOzlHx_15s

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