Interpreting correlation
Now you will learn how to compute the correlation between bond returns and equity returns. Just like volatilities, these correlations are dynamic. Therefore you need to distinguish between a static analysis that calculates correlations over a complete sample and a dynamic analysis that calculates correlations over a rolling sample. This is a similar analysis as you did for the time-varying performance evaluation in terms of mean return and volatility.
In this exercise you will learn 3 new functions from the PerformanceAnalytics package: chart.Scatter(), chart.Correlation(), and chart.RollingCorrelation().
This exercise is part of the course
Introduction to Portfolio Analysis in R
Exercise instructions
- Plot the equity returns (
returns_equities
) against the bond returns (returns_bonds
) using the functionchart.Scatter()
with the bond returns on the x-axis. Do you see a relation? - Compute the correlation between the variables
returns_bonds
andreturns_equities
usingcor()
. - Merge
returns_bonds
, andreturns_equities
usingmerge()
. Call thisreturns
. - Compute and visualize the correlation again, using chart.Correlation() with
returns
as the argument. - Compute the rolling 24-month estimates of the bond-equity correlation using the function
chart.RollingCorrelation()
.
Hands-on interactive exercise
Have a go at this exercise by completing this sample code.
# Create a scatter plot
chart.Scatter(___, ___, xlab = "bond returns", ylab = "equity returns", main = "bond-equity returns")
# Find the correlation
# Merge returns_bonds and returns_equities
returns <- merge(___, ___)
# Find and visualize the correlation using chart.Correlation
# Visualize the rolling estimates using chart.RollingCorrelation
chart.RollingCorrelation(___, ___, width = ___)