Covariance

What it means

A measure of how two variables move together. Positive means they tend to move the same way; its size depends on the units of both variables.

The exam angle

Unbounded and therefore hard to interpret on its own. Correlation is covariance scaled to [−1, 1], which is why correlation is what gets quoted.

Where it appears in the syllabus

• Quantitative MethodsCFA Level I · exam weight 11–14% · Returns and benchmarks, time value, distributions, portfolio maths, regression.
• Portfolio ConstructionCFA Level I · exam weight 8–12% · Risk and return, the CAPM, IPS construction, behavioural biases.
• Quantitative AnalysisFRM Part I · exam weight 20% · Probability, hypothesis testing, regression, time series, volatility, simulation.

Related terms

• CorrelationCovariance divided by the product of the two standard deviations, giving a unit-free number between −1 and +1.
• Standard deviationThe square root of variance, in the same units as the data.
• AlphaReturn in excess of what the asset’s risk exposures would predict.
• Arithmetic meanThe sum of the observations divided by their number.
• BootstrapResampling the observed data with replacement to estimate the sampling distribution of a statistic, without assuming a…
• Capital market lineThe capital allocation line that runs from the risk-free asset to the market portfolio, the steepest available.