FRM Part II · FRM Exam Part II · Correlation Basics: Definitions, Applications, and Terminology
Variables X and Y have standard deviations of 4% and 5%, and their covariance is 0.0010 in decimal terms (squared decimals). What is the Pearson correlation?
The Pearson correlation is 0.50. It equals the covariance of 0.0010 divided by the product of the standard deviations, 0.04 times 0.05, which is 0.0020. Dividing gives 0.50, showing a moderate positive linear relationship between the two variables.
- A0.20
- B0.50Correct
- C0.05
- D0.80
Explanation
Correlation = covariance / (sigma_X * sigma_Y) = 0.0010 / (0.04 * 0.05) = 0.0010 / 0.0020 = 0.50. The 0.20 option would come from dividing by 0.005, mistakenly using 5% only.
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