Covariance¶
One-line definition¶
Covariance measures how two return series move together in absolute return units.
Why PMs care¶
Portfolio risk depends on cross-asset covariance, not only standalone volatility.
Formula¶
Cov(X,Y) = E[(X-E[X])(Y-E[Y])]
Correlation normalizes covariance:
rho_xy = Cov(X,Y)/(sigma_x sigma_y)
Units¶
Covariance has squared-return units; correlation is unitless.
Core PM intuition¶
Diversification is produced by imperfect co-movement.
Code recipe¶
cov = returns.cov()
corr = returns.corr()
Common mistake¶
Treating a large number of holdings as synonymous with diversification.