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Knut Larsen: Demystifying Correlation

Knut Larsen: Demystifying Correlation. Simple techniques for diagnosing and quantifying correlation. Why Diagnose Correlation. Selecting investments for portfolio diversification Selecting investments for appropriate sector representation. Why Quantify Correlation.

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Knut Larsen: Demystifying Correlation

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  1. Knut Larsen:Demystifying Correlation Simple techniques for diagnosing and quantifying correlation

  2. Why Diagnose Correlation • Selecting investments for portfolio diversification • Selecting investments for appropriate sector representation Knut Larsen

  3. Why Quantify Correlation • Determine the strength of correlation • Rank investments based on correlation strength • Select most appropriate investments Knut Larsen

  4. The Raw Data Knut Larsen

  5. Time-Series Charts • Show the data in sequence • Easy to understand and interpret • May indicate type of correlation Knut Larsen

  6. Kelver versus VennesTime-series Chart Knut Larsen

  7. Scatter Diagrams • Readily show type of correlation • Indicate strength of correlation • Easily accommodate data at different levels Knut Larsen

  8. Kelver versus VennesScatter Diagram Knut Larsen

  9. Positive Correlation • Data are plotted around a line that is sloped upward to the right (positive slope) • The closer to the line the data plots are, the stronger is the correlation Knut Larsen

  10. Kelver versus GosvinTime-Series Chart Knut Larsen

  11. Kelver versus GosvinScatter Diagram Knut Larsen

  12. Negative Correlation • Data are plotted around a line that is sloped downward to the right (negative slope) • The closer the data plots are to the line, the stronger is the correlation Knut Larsen

  13. Maglin versus SelforTime-Series Chart Knut Larsen

  14. Maglin versus SelforScatter Diagram Knut Larsen

  15. Maglin versus SelforScatter Diagram Knut Larsen

  16. Uncorrelated data • Data plots are widely spread • We may draw a line that may be sloped upward or downward to the right, or with no slope at all • Since data are so spread out, the correlation is weak Knut Larsen

  17. Tallem versus SelforTime-Series Chart Knut Larsen

  18. Tallem versus SelforScatter Diagram Knut Larsen

  19. Correlation coefficient Knut Larsen

  20. Positive Correlation I III II 42.67 Knut Larsen

  21. Negative Correlation 40.58 42.67 Knut Larsen

  22. No (or low) Correlation 40.58 42.75 Knut Larsen

  23. Quantifying Correlation • If there is perfect, positive correlation, the correlation coefficient’s value is +1 • If there is perfect, negative correlation, the correlation coefficient’s value is – 1 • If there is no correlation, the correlation coefficient’s value is 0 Knut Larsen

  24. Correlation: 6 Stocks Knut Larsen

  25. Correlation: 6 Stocks Knut Larsen

  26. Required Correlation When is there enough correlation to say that there is a linear relationship? General Rule of Thumb: - a linear relationship exists if i.e. no linear relationship between Tallem and Selfor, since rxy = 0.5265 < Knut Larsen

  27. Correlation in Excel Knut Larsen

  28. Correlation in Excel Knut Larsen

  29. Correlation in Excel click Knut Larsen

  30. Correlation in Excel click Knut Larsen

  31. Correlation in Excel click Knut Larsen

  32. Correlation in Excel Knut Larsen

  33. Correlation in Excel Enter Knut Larsen

  34. Correlation in Excel click Knut Larsen

  35. Correlation in Excel the correlation coefficient for Kelver and Vennes Knut Larsen

  36. The End – Thank you for your attention Knut Larsen

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