Portfolio Covariance and Correlation: Core Workbook Concepts

Workbook structure and market scenarios

The workbook Project 2 - Covariance and Correlation organizes returns for six stocks across three states of the economy: Growth, Status Quo, and Recession, with probabilities 0.25, 0.50, and 0.25 respectively. The stock returns listed in the workbook are the starting point for all later calculations of expected return, standard deviation, covariance, correlation, and portfolio outcomes.

Expected returns from the workbook

The workbook reports expected returns for the six stocks as follows: A = 23.25%, B = 2.25%, C = 4.00%, D = 7.25%, E = 3.50%, and F = 5.00%. These values summarize the probability-weighted returns across the three economic states and provide the baseline for comparing individual securities with two-asset portfolios.

Individual risk levels

The workbook also reports standard deviations, which measure dispersion of returns around their expected values. The standard deviations are A = 4.48%, B = 1.29%, C = 7.14%, D = 9.55%, E = 2.18%, and F = 5.00%. Among these six securities, D has the largest reported standard deviation, while B has the smallest.

Equal-weight portfolio results

The workbook evaluates three equal-weight portfolios with 50% allocated to each asset in the pair. For Portfolio AB, the workbook reports CovAB = 0.0002, CorrAB = 0.2599, E[RAB] = 12.75%, and σAB = 50.14%. For Portfolio CD, it reports CovCD = 0.00058, CorrCD = 0.96, E[RCD] = 55.63%, and σCD = 87.64%. For Portfolio EF, it reports CovEF = -0.00172, CorrEF = -1.18, E[REF] = 4.25%, and σEF = 70.99%.

Interpretive takeaways from the workbook outputs

• AB shows a relatively low positive reported correlation compared with the other portfolio pairs shown.
• CD shows a very high positive reported correlation, indicating that the two assets move closely together in the workbook’s reported results.
• EF shows a negative reported covariance and a negative reported correlation value, signaling opposite movement in the workbook output.
• Across the three portfolio examples, the workbook is designed to compare how co-movement measures relate to portfolio risk and return outcomes.

What this workbook emphasizes

The central learning objective of the workbook is to connect state-contingent returns with expected return, standard deviation, covariance, correlation, and portfolio performance. By laying out the economic states, probabilities, and returns first, the workbook frames covariance and correlation as measures derived from how assets behave together across the same scenarios.