Risk & returns
Correlation describes the direction and strength of linear co-movement between two return series. It ranges from minus one to plus one under a defined sample.
Make it click
Two dancers can mirror each other, move in opposite directions or follow unrelated steps. A summary score describes their usual pairing, not every movement.
Now put that into markets
Portfolio correlation helps explain diversification because combined risk depends on co-movement as well as individual volatility.
The estimate depends on return frequency, window, currency and outliers. Correlation can change in stressed markets and misses non-linear dependence.
Show the sample period and scatter plot, not only the coefficient. Test stability across regimes and avoid mixing price levels with returns.
Correlation does not establish causation or protect against joint tail losses. A low historical estimate can rise exactly when protection is needed.
Takeaway
