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().

Plot the equity returns (returns_equities) against the bond returns (returns_bonds) using the function chart.Scatter() with the bond returns on the x-axis. Do you see a relation?
Compute the correlation between the variables returns_bonds and returns_equities using cor().
Merge returns_bonds, and returns_equities using merge(). Call this returns.
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().

Exercise

Interpreting correlation

Instructions