4M CORRELATION IN
THE STOCK MARKET
STINE AND FOSTER CHAPTER 6
MOTIVATION
A. Investors who buy stocks often buy several to
avoid putting all their eggs into one basket. Why
would someone who buys stocks care whether
the returns for these stocks were related to each
other?
B. Would investors who are concerned about putting
all their eggs into one basket prefer to buy stocks
that are positively related, unrelated, or negatively
related?
METHOD
C. How can an investor use correlations to determine
whether these three stocks are related to each other?
How many correlations are needed?
D. Correlations can be fooled by patterns that are not
linear or distorted by outliers that do not conform to
the usual pattern. Before using correlations, how can
the investor check the conditions needed for using a
correlation?
E. A key lurking variable anytime we look at a scatterplot
of two time series is time itself. How can an investor
check to see if time is a lurking factor when looking at
stock returns?
MECHANICS
F. Obtain all of the scatterplots needed to see whether
there are patterns that relate the returns of these
stocks. Does it matter which stock return goes on the xaxis and which goes on the y-axis? Do you find the
returns are associated? Is any association linear?
G. Obtain all of the correlations among these three
stocks.
H. Look at time plots of the returns on each stock. Why
are these important when looking at time series?
SUMMARY STATISTICS
Microsoft
IBM
Dell
SP500
Mean
0.025
0.012
0.042
0.008
Median
0.022
0.008
0.023
0.010
Var
0.010
0.008
0.023
0.002
StDev
0.102
0.089
0.153
0.040
CV
4.081
7.246
3.691
5.252
IQR Skewness
0.115
0.398
0.107
0.346
0.185
0.256
0.051
-0.472
HISTOGRAMS
BOXPLOTS
CORRELATION MATRIX
Microsoft
Microsoft
1.00
IBM
0.48
Dell
0.55
SP500
0.57
IBM
0.48
1.00
0.35
0.55
Dell
0.55
0.35
1.00
0.46
SP500
0.57
0.55
0.46
1.00
SCATTERPLOT MATRIX
TIMEPLOT FOR ALL STOCKS
DELL
IBM
MICROSOFT
MESSAGE
I. Summarize your analysis of the relationships
among these returns for an investor who is thinking
of buying the stocks. Be sure to talk about stocks,
not correlations.