Correlation and Regression - CFA Level 1

Why Correlation and Regression are Important:
Correlation and regression are fundamental statistical concepts in the CFA Level 1 curriculum. They help analysts understand the relationship between variables and make predictions based on historical data. Mastering these concepts is crucial for success in the Quantitative Methods section of the exam.

What are Correlation and Regression?
Correlation measures the strength and direction of the linear relationship between two variables. It ranges from -1 to +1, with -1 indicating a perfect negative correlation, +1 indicating a perfect positive correlation, and 0 indicating no correlation.

Regression is a statistical method used to model the relationship between a dependent variable and one or more independent variables. Simple linear regression involves one independent variable, while multiple regression involves two or more independent variables.

How Correlation and Regression Work:
1. Scatter plots are used to visually represent the relationship between two variables.
2. The correlation coefficient (r) quantifies the strength and direction of the linear relationship.
3. The coefficient of determination (R²) measures the proportion of the dependent variable's variance explained by the independent variable(s).
4. The regression equation (y = a + bx) is used to make predictions, where 'a' is the y-intercept and 'b' is the slope.

Exam Tips: Answering Questions on Correlation and Regression
1. Understand the difference between correlation and causation. A strong correlation does not necessarily imply causation.
2. Know how to interpret the correlation coefficient and coefficient of determination.
3. Be able to calculate and interpret the regression equation.
4. Recognize the assumptions of linear regression, such as linearity, normality, and homoscedasticity.
5. Practice interpreting scatter plots and identifying outliers.
6. Understand the limitations of correlation and regression, such as the impact of outliers and the potential for spurious correlations.

By mastering these concepts and following these exam tips, you'll be well-prepared to tackle questions on correlation and regression in the CFA Level 1 exam.