Question

Suppose the return of asset S is -0.25 times the return of asset A. That is, r S = − 0.25 r A. What is the correlation between the returns of S and A ? Explain clearly.

Answer 1

Correlation is measured on a scale of -1.0 to +1.0:

1. If two assets have an expected return correlation of 1.0, that means they are perfectly correlated. If one gains 5%, the other gains 5%. If one drops 10%, so does the other.
2. A perfectly negative correlation (-1.0) implies that one asset's gain is proportionally matched by the other asset's loss.
3. A zero correlation indicates the two assets have no predictive relationship.

In the given question, the return of asset S is -0.25 times the return of asset A.

That is, r S    = -0.25 r A

Therefore, the Correlation between the returns of assets S and A is = -0.25

That means the given assets have Negative Correlation.