What is Covariance in statistics
Covariance is a mathematical or statistical tool which measures the relationship between two random variables. Covariance evaluates how much – to what extent – the variables change together.
The covariance can take any positive or negative value and it interprets as
- Positive covariance: Indicates that two variables tend to move in the same direction.
- Negative covariance: Indicates that two variables tend to move in inverse directions.
The widespread use of Covariance is in finance for portfolio modelling to diversify the assets. We are choosing assets which don’t show a high positive covariance with each other and the unsystematic risk can be partially eliminated.
Mathematical calculation of covariance will be as given be: