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How to Calculate Covariance.
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How to Calculate Covariance.

Rosemary Njeri

Covariance measures the directional relationship between the return on two assets.

Covariance is used in portfolio theory to determine what assets to include in the portfolio.

Formula to calculate covariance.

How to Calculate Covariance.

x is the data value of x

y is the data value of y

μx is the mean of x

μy is the mean of y

N is the number of data values

Example:

Suppose an analyst observed the behavior of stock x and y. If the return of stock x is 2000 and the mean is 150, calculate the covariance if the return of stock y us 1500 and its mean is 120 when N is 5.

Since we already have the return in total, we do not need to do any summation, we will just plug our values in the formula.

How to Calculate Covariance.
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