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Finance: What is Inverse Correlation? 1 Views
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What is inverse correlation? An inverse correlation is a relationship between two variables in which one moves in the opposite direction to the other. For example, bond prices and yields can be said to have an inverse correlation, since if bond prices go down, yields go up, and vice versa. One variable does not necessary cause the other; it can be a correlation that happens for a variety of reasons and not be consistent, such as the strength of US Dollar vs. world gold prices.
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Transcript
- 00:00
Finance Allah Shmoop What is inverse correlation All right It's
- 00:07
the relationship between two variables where we can expect an
- 00:10
increase in one variable to be paired with a decrease
- 00:13
in another variable Alright in plain English correlation When it
- 00:17
rains you get wet Inverse correlation When it rains you
Full Transcript
- 00:22
get dry Correlation You have a big brain So your
- 00:26
smart inverse correlation like we're thinking dinosaurs Maybe they had
- 00:30
big brains all of it But if they had big
- 00:32
brains the bigger their brain Well the dumber thing God
- 00:35
Well that would be an inverse correlation right Correlation You
- 00:38
drive a fast flashy cars so you probably have a
- 00:41
small garage Alright Inverse correlation You drive a fast flashy
- 00:45
car and everything else about you is enormous Yeah So
- 00:49
in a word in versus just opposite check out inverse
- 00:52
correlations in this table showing to data sets Note how
- 00:55
the returns on investment in gold increase while the returns
- 00:58
on investment in Pat's for cats decrease over the same
- 01:02
timeframe And instead of hats for cats you could have
- 01:05
seen the stock market because people typically retreat into gold
- 01:08
when they're nervous about equities So this is really not
- 01:10
a bad inverse correlation right Okay So let's take a
- 01:13
look at a scatter plot of the same two data
- 01:14
sets See how the data points get lower and lower
- 01:17
as we go farther to the right Yeah that's because
- 01:19
the X values or the returns on the gold investment
- 01:22
increase or go farther to the right Well then the
- 01:25
Y values or returns on the hats for cats equities
- 01:28
investment decrease or go closer to the Y axis Well
- 01:31
sometimes we want to put a number on how strong
- 01:34
or weak The inverse correlation is between any two pairs
- 01:38
of variables So basically we're trying to determine if the
- 01:40
inverse correlation is one that follows a very steady amount
- 01:44
of decrease in one variable for a fixed amount of
- 01:47
increase in the other or if the amount of decrease
- 01:50
in one variable fluctuates for a fixed increase in the
- 01:53
other or more simply how closely the points on the
- 01:56
scatter plot are to an imaginary line like this thing
- 01:59
that best represents them Right That's an r squared correlation
- 02:02
there we'll get to it So the measure of how
- 02:04
strong the correlation is between these two variables is called
- 02:08
yes the correlation coefficient or our value Well a strong
- 02:13
inverse correlation would have the data points all cozied up
- 02:17
to the best fitting line coincidently called the line of
- 02:21
best fit Kind of like all of your new you
- 02:23
know friends after you win the ninety million dollars Powerball
- 02:27
lottery Well a week inverse correlation would have the data
- 02:32
spread out away from the line and best fit So
- 02:34
there's really no clustering here It's just a whole bunch
- 02:36
of dots on a graph that don't really tell you
- 02:39
much of anything you know like the location of kids
- 02:41
at a middle school dance compared to the location of
- 02:44
the dance floor So how do we find the our
- 02:46
value to determine how strong our correlation is inverse or
- 02:50
otherwise Well typically people use some sort of technological gadgets
- 02:53
such as a graphing calculator spreadsheet or a nap Let's
- 02:56
take that investment data from before comparing Gold returns to
- 02:59
returns on equity and hats for cats and walked through
- 03:02
how you'd find the R value using a spreadsheet So
- 03:05
open your favour like Excel or Google sheets or OpenOffice
- 03:08
Cal Core sells for days or and whatever you use
- 03:11
We're using Excel for this demo but they all work
- 03:13
in basically the same Put the data for the gold
- 03:15
returns without the presented signs in the first column Put
- 03:18
the data from hats for cats also without the presented
- 03:20
signs In the second column like that go to any
- 03:22
blank cell like the top selling the third column C
- 03:25
one there Then click on the formula's tab Choose the
- 03:28
Mohr Functions button and Anju Statistical See the coral option
- 03:32
there you selected Once we choose correlation we'll get a
- 03:35
pop up asking us to define the two sets of
- 03:37
data highlight on ly the first column of data It
- 03:40
should load that set of cells in the top row
- 03:42
of the pop up All right now left Click in
- 03:44
the second row of the pop up Highlight on ly
- 03:46
the second column of data and well should slide those
- 03:50
cells right into place Got it Okay So click okay
- 03:52
and boom instant our value Well it should show up
- 03:55
in the cell you picked to enter the Correlation Command
- 03:58
See one If you followed our Russians to et You
- 04:01
know t looks like our correlation has the strength of
- 04:03
negative point eight four Oh one Okay But like what
- 04:06
does that mean Is that strong or weak Positive Negative
- 04:10
Well for inverse correlations there's a range of values between
- 04:14
zero and negative one that we consider strong medium and
- 04:17
weak Inverse correlations like strong inverse correlation is generally run
- 04:21
from about negative point seven The negative one These will
- 04:23
be scatter plots where the points are quite close to
- 04:26
the best fit line like they're extremely counter or inversely
- 04:30
correlated Like if you found that every guy over forty
- 04:34
who drove a red convertible portion wore a gold chain
- 04:37
necklace there had a really big garage well then it
- 04:40
would be negatively correlated to our expectations Okay medium inverse
- 04:45
correlation is generally run from about negative point For the
- 04:48
negative point seven seas will be scattered plots with points
- 04:50
group less closely around the line A best fit Think
- 04:53
about it like well maybe half to two thirds of
- 04:55
all the guys have a small garage versus a big
- 04:58
garage Yeah something like that Weak inverse correlation is generally
- 05:01
run from well zero toe negative point for easily scatter
- 05:04
plots with almost no riel tight grouping Maybe there's some
- 05:07
trend if you really study it hard and think about
- 05:10
Roar Shack But there's really no correlation between the size
- 05:13
of your garage and when you're driving a convertible red
- 05:15
portion you wear a gold chain necklace All right one
- 05:18
thing we have to be careful about With the inverse
- 05:19
correlation XYZ thie implied value judgments that mistakenly get applied
- 05:22
to the two variables that are inversely correlated like in
- 05:25
our correlation calculation on returns we saw the gold investment
- 05:28
rise while the equity in hats for cats investment had
- 05:31
decreasing returns and basically was saying that people retreated putting
- 05:36
there cash into gold when they were nervous about the
- 05:38
equity markets Well that doesn't mean gold will always be
- 05:41
the one to increase While hats for cats decreases Beyond
- 05:44
the obvious changes in the market that might make gold
- 05:47
suddenly tank an inverse correlation means that gold could be
- 05:50
the investment with decreasing returns While hats for cat shows
- 05:54
increasing returns right the correlation thing is just showing that
- 05:57
they're inversely correlated When one goes up the other goes
- 06:00
down It could be that well when one goes down
- 06:02
the other one goes up Got it by the biggest
- 06:04
takeaway smelling That inverse correlation means that as one variable
- 06:08
increases in general the other variable decreases particularly when you
- 06:12
have high R squared correlations there Also we can calculate
- 06:15
how strong the correlation is by finding the R value
- 06:18
which we typically do using some technological do Dad Yeah
- 06:21
thank you Google Sheets and excel in all that stuff
- 06:23
Inverse correlation Czar values run from zero to negative one
- 06:27
with strong being in close to negative one in week
- 06:30
being close to zero And we're hoping there's an infamous
- 06:33
correlation between the number of matches we get on tinder
- 06:35
and the number of dates when we get that in
- 06:37
badly But well so far the data is not backing 00:06:41.135 --> [endTime] us up Change our picture what Oh
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