Risk and Return Measures - Statistical Risk Measures

  1. Correlation Coefficient - A statistic gauging the relationship between two variables. The range is from -1 to +1. -1 indicates inverse correlation, 0 indicates no relationship between the variables and +1 indicates complete correlation between them.
  2. Coefficient of Determination (R2) - A statistical measure which one arrives at by squaring the correlation coefficient. This statistic describes the degree of variability of a dependent variable that is explained by changes in the independent variable. As an example, if the R2 is 63% between a large cap core stock and the S&P 500, that signifies that changes in the S&P 500 (systematic risk) explains 63% of the movement of the stock, whereas unsystematic risk accounts for the remaining 37%.

Look Out!

Expect a question or two on how to interpret R2 given a particular scenario.

  1. Coefficient of Variation - The measure of dispersion of a probability distribution. The standard deviation divided by the mean. In finance, the ratio measures the amount of risk per unit of mean return and is helpful in gauging relative risk in terms of degree of data dispersion. The formula is written as follows: Cv=σ/µ
  2. Standard Deviation (σ) - Standard deviation is a measure of total risk, defined as the sum of systematic and non systematic risk. One may define it as the dispersion of outcomes around the mean, which is the average return for a sample of data. Accordingly, it is a measure of central tendency. The greater an investment's standard deviation, the greater is its risk.
    • Approximately 68% of outcomes fall within one standard deviation of the mean, both above and below.
    • Approximately 95% of outcomes fall within two standard deviations of the mean, both above and below.
    • Approximately 99% of outcomes fall within three standard deviations of the mean, both above and below.
An example may illustrate these points. Six ? Corporation yields a mean return of 21% with a standard deviation of 9%.
    • 68% of outcomes fall between 30% and 12% (21% +/-9%, respectively)
    • 95% of outcomes fall between 39% and 3% (21% +/-2x9%, respectively)
    • 99% of outcomes fall between 48% and -6% (21% +/-3x9%, respectively)

      Look Out!

      Expect a question or two on how to interpret R2 given a particular scenario.


Correlation and Volatility Statistics
Related Articles
  1. Investing Basics

    Explaining Risk-Adjusted Return

    Risk-adjusted return is a measurement of risk for an investment or portfolio.
  2. Investing Basics

    Calculating the Margin of Safety

    Buying below the margin of safety minimizes the risk to the investor.
  3. Mutual Funds & ETFs

    ETF Analysis: PowerShares S&P 500 Downside Hedged

    Find out about the PowerShares S&P 500 Downside Hedged ETF, and learn detailed information about characteristics, suitability and recommendations of it.
  4. Mutual Funds & ETFs

    ETF Analysis: Guggenheim Enhanced Short Dur

    Find out about the Guggenheim Enhanced Short Duration ETF, and learn detailed information about this fund that focuses on fixed-income securities.
  5. Mutual Funds & ETFs

    ETF Analysis: iShares Morningstar Small-Cap Value

    Find out about the Shares Morningstar Small-Cap Value ETF, and learn detailed information about this exchange-traded fund that focuses on small-cap equities.
  6. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI KLD 400 Social

    Find out about the iShares MSCI KLD 400 Social exchange-traded fund, and learn detailed information about its characteristics, suitability and recommendations.
  7. Mutual Funds & ETFs

    ETF Analysis: Guggenheim BulletShrs 2018 HY CorpBd

    Find out about the Guggenheim BulletShares 2018 High Yield Corporate Bond ETF, and get information about this ETF that focuses on high-yield corporate bonds.
  8. Mutual Funds & ETFs

    ETF Analysis: PowerShares DWA SmallCap Momentum

    Find out about the PowerShares DWA SmallCap Momentum Portfolio ETF, and explore detailed analysis the fund's characteristics, suitability and recommendations.
  9. Mutual Funds & ETFs

    ETF Analysis: ProShares Large Cap Core Plus

    Learn information about the ProShares Large Cap Core Plus ETF, and explore detailed analysis of its characteristics, suitability and recommendations.
  10. Mutual Funds & ETFs

    ETF Analysis: iShares Core Growth Allocation

    Find out about the iShares Core Growth Allocation Fund, and learn detailed information about its characteristics, suitability and recommendations.
RELATED TERMS
  1. Net Line

    The amount of risk that an insurance company retains after subtracting ...
  2. Political Risk Insurance

    Coverage that provides financial protection to investors, financial ...
  3. Maximum Drawdown (MDD)

    The maximum loss from a peak to a trough of a portfolio, before ...
  4. Gross Exposure

    The absolute level of a fund's investments.
  5. Priori Loss Estimates

    A technique used by insurance companies to calculate loss reserves.
  6. Value Of Risk (VOR)

    The financial benefit that a risk-taking activity will bring ...
RELATED FAQS
  1. Is my IRA/Roth IRA FDIC-Insured?

    The Federal Deposit Insurance Corporation, or FDIC, is a government-run agency that provides protection against losses if ... Read Full Answer >>
  2. Does index trading increase market vulnerability?

    The rise of index trading may increase the overall vulnerability of the stock market due to increased correlations between ... Read Full Answer >>
  3. What are common delta hedging strategies?

    The term delta refers to the change in price of an underlying stock or exchange-traded fund (ETF) as compared to the corresponding ... Read Full Answer >>
  4. How does being overweight in a particular sector increase risk to a portfolio?

    An investor who is overweight in a particular sector risks a loss in value for the portfolio if there is a downturn in that ... Read Full Answer >>
  5. What are the primary risks an investor should consider when investing in the retail ...

    The retail sector consists of companies operating in multiple industries such as specialty retail, general retail, food and ... Read Full Answer >>
  6. What risks do I face when investing in the insurance sector?

    Like all equity investments, insurance companies present investors with market risk. Insurance companies, like banks, also ... Read Full Answer >>
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!