What is 'Covariance'
Covariance is 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 move inversely.
One method of calculating covariance is by looking at return surprises (deviations from expected return) in each scenario. Another method is to multiply the correlation between the two variables by the standard deviation of each variable.
BREAKING DOWN 'Covariance'
Possessing financial assets that provide returns and have a high covariance with each other will not provide very much diversification.
For example, if stock A's return is high whenever stock B's return is high and the same can be said for low returns, then these stocks are said to have a positive covariance. If an investor wants a portfolio whose assets have diversified earnings, he or she should pick financial assets that have low covariance to each other.

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How is covariance used in portfolio theory?
Learn how covariance is used to reduce risk in modern portfolio theory, how covariance is calculated and how it is used to ... Read Answer >> 
How do you interpret the magnitude of the covariance between two variables?
Learn more about covariance and how financial planners and economists use the concept. Explore an example of covariance in ... Read Answer >> 
How does covariance impact portfolio risk and return?
Understand how covariance is related to the risk and return of a portfolio of stocks, and learn how covariance is used to ... Read Answer >> 
What is the difference between variance and covariance?
Learn more about the differences between covariance and variance, and how these metrics can be of use to you in minimizing ... Read Answer >> 
Can a mean variance analysis be done for any investment?
Learn how mean variance analysis is used in modern portfolio theory to create an optimal mix of assets to maximize return ... Read Answer >> 
According to the CAPM, the expected return on a stock, that is part of a portfolio, ...
A. the covariance between the stock and the market. B. the variance of the market. C. the market risk premium. D. ... Read Answer >>