CFA Level I · CFA Level I Exam · Statistical Characteristics of Asset Returns
Which feature of correlation most likely makes it more convenient than covariance for comparing the relationships among several pairs of assets?
Correlation is bounded between -1 and +1 because it standardizes covariance by both standard deviations. This makes the strength of relationships comparable across different asset pairs. It does not capture nonlinear relationships, and outliers can distort it considerably.
- AIt is bounded between -1 and +1Correct
- BIt captures nonlinear relationships
- CIt is unaffected by outliers
Explanation
Correlation standardizes covariance by the standard deviations, so it lies between -1 and +1 and is unit-free, allowing comparison across pairs. It measures only linear association and is sensitive to outliers.
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