Correlation simply refers to a relationship between two events. For example, there is a correlation between how much you earn and how much tax you pay. In finance terms, it generally describes the extent to which the prices of two different assets tend to move up and down together. If one moves and the other does too, in the same direction, they are said to have positive correlation. If they move in perfect unison, they are perfectly positively correlated, and have a ‘correlation coefficient’ of +1. Assets are perfectly negatively correlated when, for every point one goes up, the other goes down by an identical percentage. The correlation coefficient is then -1. A correlation coefficient of 0 means that there is no relationship at all. Correlation generally occurs when events in one area have an obvious influence on another. For example, a change in consumer confidence has a relationship with high-street spending and so will be correlated to the share prices of retailing firms. In the same way, if an Asian economy is perceived as being dependent on the US economy, any movement in the US market will cause a corresponding movement in the Asian market.
In a series of three short videos, Merryn Somerset-Webb talks to Hugh Hendry, manager of the Eclectica hedge fund, about everything from China to the US, Europe, and Japan.
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