Understanding the Difference Between Correlation, Covariance, and Variance with Examples

By
A.Sulthan, Ph.D.,
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In the world of statistics and data analysis, there are several measures that help us gain insights into the relationships between variables. Three such measures often encountered are correlation, covariance, and variance. While they are related, it’s important to understand their unique characteristics and applications. In this blog post, we will explore the differences between correlation, covariance, and variance, along with practical examples to illustrate their usage.

Variance

Variance is a fundamental statistical concept used to describe the dispersion or spread of a set of values. It measures how much the individual data points in a dataset deviate from the mean. Variance is calculated by taking the average of the squared differences between each data point and the mean. Mathematically, it is denoted as σ² (sigma squared) for a population or s² (squared) for a sample.
Example: Consider a dataset representing the daily temperatures in a particular city over a week: [25, 28, 26, 23, 27, 25, 24]. To calculate the variance, we first find the mean, which is (25+28+26+23+27+25+24)/7 = 25.14. Then, we calculate the squared differences between each data point and the mean: [(25-25.14)², (28-25.14)², (26-25.14)², (23-25.14)², (27-25.14)², (25-25.14)², (24-25.14)²]. Taking the average of these squared differences gives us the variance.

Covariance

Covariance measures the relationship between two variables and describes how they change together. It indicates whether the variables move in the same direction (positive covariance) or in opposite directions (negative covariance). Covariance is influenced by the scale of the variables, making it difficult to compare across different datasets. Mathematically, covariance between two variables X and Y is denoted as cov(X, Y).
Example: Let’s consider two variables: the number of hours spent studying and the corresponding test scores of a group of students. The dataset might look like this:

Hours Studied: [5, 3, 7, 2, 6] Test Scores: [60, 50, 70, 45, 65]

To calculate covariance, we first find the means of both variables: mean(Hours Studied) = 4.6 and mean(Test Scores) = 58. Next, we calculate the differences between each data point and its respective mean, multiply them, and take the average. The resulting value represents the covariance between the two variables.

Correlation

Correlation is a standardized measure that quantifies the strength and direction of the linear relationship between two variables. It ranges from -1 to 1, with 0 indicating no linear relationship. Correlation is scale-invariant, making it easier to compare across different datasets. The most commonly used correlation coefficient is Pearson’s correlation coefficient, denoted as r.

Example: Building upon the previous example, let’s calculate the correlation coefficient between the hours spent studying and the corresponding test scores. We can use the same dataset:

Hours Studied: [5, 3, 7, 2, 6] Test Scores: [60, 50, 70, 45, 65]

By applying the formula for Pearson’s correlation coefficient, we can calculate the correlation between these variables. The resulting value will range between -1 and 1, indicating the strength and direction of the linear relationship between the variables.

In summary, variance measures the spread of a dataset, covariance measures the relationship between two variables, and correlation quantifies the strength and direction of the linear relationship between two variables. While covariance and correlation are related to each other, correlation is a more standardized measure that allows for easier interpretation and comparison across datasets. Understanding these concepts is essential for effectively analyzing data and drawing meaningful insights from statistical measures.

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A.Sulthan, Ph.D.,
A.Sulthan, Ph.D.,
https://g.co/kgs/881Hce
Author and Assistant Professor in Finance, Ardent fan of Arsenal FC. Always believe "The only good is knowledge and the only evil is ignorance - Socrates"
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