Question

Suppose there are two stocks, A and B. Also suppose there are two possible outcomes. Outcome 1 happens with 40% probability and outcome 2 happens with 60% probability. In outcome 1, stock A has 11% return and stock B has 5% return. In outcome 2, stock A has -2% return and stock B has 9% return. What is the correlation of their returns?

		-1
		-60.56935191
		-0.001248
		-0.228735683

Answer 1

Solution

Calculating the Correlation between Stock A and Stock B's return:-

Prob (P)	Stock Return (A)	Stock Return (B) (%)	(P)*Stock A	(P)*Stock B	Deviation           [R-E(A)]	Deviation        [R-E(B)]	[R-E(A)]*[R-E(B)]	{[R-E(A)]*[R-E(B)]}* (P)
0.40	0.110	0.05	0.0440	0.0200	0.0780	-0.0240	-0.001872	-0.000749
0.60	-0.020	0.09	-0.0120	0.0540	-0.0520	0.0160	-0.000832	-0.000499
			E(A)=0.0320	E(B)=0.0740				-0.001248

Correlation between Stock A and Stock B's return

= -0.001248

Option C