covariance

Covariance

A measure of the degree to which returns on two risky assets move in tandem. A positive covariance means that asset returns move together. A negative covariance means returns vary inversely.

One method of calculating covariance is by looking at return surprises (deviations from expected return) in each scenario. Another method is to multiply correlation between the two variables by the standard deviation of each variable.

Notes:

If you owned one asset that had a high covariance with another asset that you didn't own, then you would receive very little increased diversification by adding the second asset. Of course, the opposite is true as well, adding assets with low covariance to your portfolio lowers overall portfolio risk.

See also: Correlation, Modern Portfolio Theory, Standard Deviation

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Covariance

A statistical measure of the degree to which random variables move together. A positive covariance implies that one variable is above (below) its mean value when the other variable is above (below) its mean value.

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covariance

A statistical measure of the extent to which two variables move together. Covariance is used by financial analysts to determine the degree to which return on two securities is related. In general, a high covariance indicates similar movements and lack of diversification. Compare variance. See also risk.