Portfolio Correlation

Portfolio Correlation Definition

Portfolio Correlation measures the degree that each investment in a portfolio moves relative to another investment within the portfolio. 

 

How we Calculate Portfolio Correlation

Within a portfolio, investments are correlated against each other, as opposed to a benchmark. Therefore, we use two different formulas, depending on what we are calculating the Correlation of.

To see how we calculate Benchmark Correlation, click here.

The formula we use to calculate Portfolio Correlation is:

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Where:

w1 = Proportion of the portfolio invested in Asset 1

w2 = Proportion of the portfolio invested in Asset 2

σ1 = Asset 1 standard deviation of returns

σ2 = Asset 2 standard deviation of returns

ρ1,2 = Correlation coefficient between the returns of Asset 1 & Asset 2

 

Correlation Matrix

In order to visualize the Correlation within a portfolio, the standard is to use a matrix. This helps identify multiple funds within a portfolio that are highly correlated. An example is below:

 

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