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Tracking Correlations: Risk, Trailing correlations, correlation coefficients and Trading decisions

Agnes recently did a lot of work in putting together a short course on correlations from a risk and trading point of view. Unlike the boring text book stuff, there are some interesting lessons and applications here if you want to track correlations over a period of time as a trader or risk manager. This is the same methodology we use to track crude oil, precious metals (gold, silver) and currencies as part of our own internal analysis. Given the number of queries we get on our methodology I thought this post should put a lot of questions to rest.

Enjoy the course.

Correlation – Introduction

Next raw data time series line graphs such as price trends and derived data graphs such as volatility trend lines including the methodology for constructing line graphs in EXCEL.

Correlation – Times series data graphs –Prices & More

Scatter plots, a visual representation of the correlation coefficient tackled a little bit later on the course.

Correlation – Scatter Plots

An example of the calculation of the correlation coefficient method is given in our available-for-sale Computational Finance – EXCEL examples course “Portfolio Risk Metrics Example“.

Correlation – Correlation coefficient, r

The trailing correlations graph, a graphical representation of how correlations have changed over a period of time.

Correlation – Trailing correlations

Finally, we look at an additional way of viewing the time series data of two factors- the relative price graph and its various uses:

Correlation – Relative Price Graphs

One thought on “Tracking Correlations: Risk, Trailing correlations, correlation coefficients and Trading decisions”

  1. Kendall says:

    The value of risk-adjusted returns depdens on how you do the adjusting. The CAPM way is to make investing at the risk-free rate the same as investing in a stock index. This type of risk-free rate is used as a way to measure whether your portfolio is on the efficient frontier. But this has little to do with an investor’s risk tolderance. The way that I do risk-adjusted returns for myself is based on maximizing the compound return of my portfolio with the added consideration of avoiding big blowups (black swan events) to the extent that I can. Morningstar have their own version of risk-adjusted returns that is roughly 3 times more punitive to the level of volatility than my approach is. Morningstar claim that their method best matches investor feelings, but I’m not overly concerned about emotional responses from the typical investor in choosing my own portfolio.

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