Page 46 - FINAL CFA SLIDES DECEMBER 2018 DAY 3
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LOS 9.k: Calculate and interpret Session Unit 2:
covariance and correlation, p.183
9. Probability Concepts
Example: Covariance: Assume that the economy can be in three possible states (S) next year: boom,
normal, or slow economic growth. An expert source has calculated that P(boom) = 0.30, P(normal) = 0.50,
and P(slow) = 0.20. The returns for Stock A, RA, and Stock B, RB, under each of the economic states are
provided in the probability model below. What is the covariance of the returns for Stock A and Stock B?
Cov(Ri, Rj) =
E{[Ri – E(Ri)] * [Rj – E(Rj)]}
In more complex applications, there would likely be positive
values where the zeros appear in the table. In any case, the
sum of all the probabilities in the cells on the table must
equal 1, p184
