Correlation Coefficient

Coefficient of correlation

Correlation analysis attempts to determine the degree of

relationship between variables.

It measures the degree of relationship between two or

more variables. The degree of correlation states about the
extent of the closeness of two sets of variables.

For example, there exists some relationship between price

and demand, heights of fathers and daughters, wages and
price index, yield and rainfall, sales and advertisement.
Thus, correlation is a statistical tool which helps us in
analyzing the co-variation of two or more variables.

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Coefficient of correlation

The study of correlation analysis is useful both in physical and social

sciences. The following are the usefulness of correlation in the field of
business and economics.
(i) Correlation analysis helps in quantifying precisely the degree and
direction of such relationships between variables.

(ii) It is very useful for making forecasts in economic and business

activities. In business, it enables us to estimate cost, sales on the basis
of observation recorded on functionally related variables with these
dependent variables.

(iii) It contributes to the understanding of economic behaviour, aids in

locating the critically important variables, on which other depend, may
reveal to the economist.

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Coefficient of correlation

(iv) The effect of correlation is to reduce the range of uncertainty of our

prediction. The prediction based on correlation analysis will be more
reliable and near to reality.

(v) Correlation is a powerful statistical tool that provides quantitative

expressions of the manner or extent of which events are related
mathematically.

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Recall: Covariance

 ( x  X )( y  Y )
i i
cov ( x , y )  i 1
n

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Interpreting Covariance

cov(X,Y) > 0 X and Y are positively correlated

cov(X,Y) < 0 X and Y are inversely correlated

cov(X,Y) = 0 X and Y are independent

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Coefficient of correlation

Karl Pearson’s correlation coefficient measures quantitatively the extent

to which two variables x and y are correlated. For a set of n pairs of
values of x and y, Pearson’s correlation coefficient r is given by

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Coefficient of correlation

Step Deviation Method for Grouped Data: When data on x and y values are
classified or grouped into a frequency distribution, the formula is

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Correlation coefficient

 Pearson’s Correlation Coefficient is

standardized covariance (unitless):

cov ariance( x, y )
r
var x var y

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Calculating by hand…

 ( x  x )( y  y )
i 1
i i

cov ariance( x, y) n
rˆ  
n n
var x var y
 i
( x
i 1
 x ) 2
 i
( y
i 1
 y ) 2

n n

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Coefficient of correlation

The coefficient of correlation always varies between the two limits of

+1 and --1.

When there is perfect positive correlation its value is +1 and when there
is perfect negative correlation its value is -1.

Its mid-point is 0, which indicates absence of correlation.

As the value of this coefficient decreases from the upper limit of +1, the
extent of positive correlation between the two variables also declines.
When it reaches the value of 0 it indicates complete absence of
correlation and when it goes further down in negative values (less than
zero) it indicates negative correlation. When it reaches the other limit of
-1 there is evidence of perfect negative correlation between the two
series.

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Correlation

Measures the relative strength of the linear

relationship between two variables
Unit-less
Ranges between –1 and 1
The closer to –1, the stronger the negative linear
relationship
The closer to 1, the stronger the positive linear relationship
The closer to 0, the weaker any positive linear relationship

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 Scatter Plots of Data with Various Correlation
Coefficients

Y Y Y

X X X
r = -1 r = -.6 r=0
Y
Y Y

X X X
r = +1 r = +.3 r=0
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Linear Correlation

Linear relationships Curvilinear relationships

Y Y

X X

Y Y

X X
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Linear Correlation

Strong relationships Weak relationships

Y Y

X X

Y Y

X X
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Linear Correlation
No relationship

X
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Computational Formulas -- Covariance

There is a computational formula for covariance

similar to the one for variance. Indeed, the
latter is a special case of the former, since
variance of a variable is “its covariance with
itself.”
 N N

1  N  X i  Yi 
sxy    X iYi  i 1 i 1

N  1  i1 N 
 
 
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Computational Formula for Correlation
By substituting and rearranging, you obtain a substantial
(and not very transparent) formula for rxy

N  XY   X  Y
rxy 
 N X 2   X 2   N Y 2   Y 2 
      

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Computing a correlation

Cigarettes Lung
(X) Capacity
X2 XY Y2 (Y)
0 0 0 2025 45
5 25 210 1764 42
10 100 330 1089 33
15 225 465 961 31
20 400 580 841 29
50 750 1585 6680 180
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Computing a Correlation

(5)(1585)  (50)(180)
rxy 
(5)(750)  50  (5)(6680)  180 
2 2

7925  9000

(3750  2500)(33400  32400)
1075
  .9615
1250  (1000)
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Coefficient of correlation

Find out the correlation co-efficient between height of mothers and

height of daughters:
Height of mother (in cm): 150 152 156 157 160
Height of daughter (in cm): 148 145 160 156 150

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Coefficient of correlation

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Coefficient of correlation

Find out the correlation coefficient between heights of father and son
from the following data
Height of father
in inches: 65 66 67 67 68 69 70 72
Height of son
in inches: 67 68 65 68 72 72 69 71

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Coefficient of Correlation

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Coefficient of Correlation

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Coefficient of Correlation

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Coefficient of Correlation

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Coefficient of Correlation

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