Why is the correlation low when returns are high and vice versa?

No Bill - you are completely missing the point. The original poster is now confused and admitted this whole thing added no value. Congrats for confusing the **** out of everyone here. The point of AF is to help each other pass the exam - not badger every little statement someone makes.

In fact I will no longer post on AF. The time I waste here trying to help my fellow candidates could be used for studying or just other things as it relates to life in general. Ill let you waste your days one-upping candidates on AF to feel better about yourself.

Good luck to everyone in June. I hope to see many of you with the designation after your names and wish you the best of luck in the future with your careers.

Sign off.

Question one Excel gave me a correlation on prices of approximately .995. Question two I got a correlation of -1. Thank you for the example Bill and apparently at the time reading through this thread my mind did have a fundamental breakdown in the meaning of correlation. I think this was blown up way too much but was a good exercise for me either way. I want to be in clear in that I never stated, or have ever anywhere on AF that I am an expert in anything or know any more than anyone else. In fact, I typically disclose I am only a candidate and it is important everyone on here checks who people are, being a Charterholder, level I i ii or iii candidate before taking their advice. I see level one candidates on our III forum trying to give advice to us at times. I sigh but who knows, they may have value to add. I want you to know I am here to actually learn and not to show anyone up, that’s not what I was remotely trying to do here with you. I acknowledge your wiser, more intelligent than I so lets just make sure that’s clear. I want to be clear because it seemed like you may have been under the impression by your demeanor that I was disagreeing with you or trying to imply I know something you do not.

Now back to the actual content. It was important for me to understand where my fundamental flaw was being derived from so back to level one I went and reviewed our old correlation formula. (Covariance/(SD*SD)). After this I needed to rationalize why prices can be moving down at the same time having positive price correlation yet negative return correlations. This is where I realized the numerator of our correlation formula is crucial. The denominator will always be positive as SD (standard deviation) cannot be negative. Then I needed to review covariance to make sure I was understanding that correctly and how it becomes positive or negative at any given time interval. The only way for the correlation formula to be negative is for covariance to be negative. Covariance can only be negative if one of the assets returns is BELOW its average return while the other asset is ABOVE its mean, on average over the time period. That’s when it started to make sense. In a down trending market or contagion situation equity prices will become more positively correlated because all their prices are now falling below their historical means at the same time. However, their return correlations can be quite different such as in your example, where all the prices were positively correlated falling below there averages at the same time, however, the returns were oscillating between one asset being above its return average while the other asset was below its return average gicing a negative correlation.

Please tell me I got this right now…

This seems to be the part a lot of people miss. Good job for actually grappling with and understanding what the formula tells you.

As for all the claims about “needing to be exact” and “confusing people” for correcting something that’s at best ambiguous and likely wrong: imprecision and complaining about a need for accuracy is usually the war drum of the uninformed or the sloppy.

Understood now thank you for pointing out the distinction.

You got this right now.

The point is exactly (sorry) what you realized: that the relationship is relative to each variable’s mean, not to some absolute value such as zero.

So . . . you accept no responsibility for the confusion. That’s too bad.

I agree. And I have a pretty good track record in that respect.

So do you, by the way.

That’s unfortunate, as you do a lot of good here.

Don’t quit your day job to become a psychoanalyst.

I, for one, am sorry that this thread devolved into apparent animosity, and that I contributed to that. I’ll be more careful in the future.