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CFA Level I · CFA Level I Exam · Statistical Characteristics of Asset Returns

An analyst observes that the covariance between the monthly returns of Stock X and Stock Y is positive. Which conclusion is most likely supported by this observation?

A positive covariance indicates that the two return series tend to deviate from their means in the same direction. It does not compare volatilities, and it contradicts linear independence, which would give zero covariance. Its magnitude is also not standardized.

  1. AThe returns tend to move in the same direction relative to their meansCorrect
  2. BStock X has a higher standard deviation than Stock Y
  3. CThe returns of the two stocks are linearly independent

Explanation

A positive covariance means that deviations from the mean tend to have the same sign, so the returns tend to move together. Covariance says nothing about which asset is more volatile. Independence would imply zero covariance, not a positive one.

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