Why does computing correlation between index levels vs. percentage changes yield completely different results?

I am examining the relationship between the S&P 500 and the Industrial Production Index. Computing the correlation between these these variables yield vastly different results if expressed in percentage changes as opposed to using the index approach (i.e. choosing an index year and multiplying the percentage changes).

Percentage changes CORR (S&P500, IndustrialProduction) = -0.006460759

Index levels CORR (S&P500, IndustrialProduction) = 0.890445169

How does this make sense?

edited Oct 7 '18 at 18:30

Alex C

5,90111022

asked Oct 7 '18 at 17:28

DBE7

1

$\begingroup$ stats.stackexchange.com/a/7378 explains it all $\endgroup$ – Ivan Oct 7 '18 at 17:33
$\begingroup$ The index level correlation is not valid and should be disregarded. It is a so-called "spurious correlation" between two random walks. fsb.miamioh.edu/lij14/672_2014_s8.pdf $\endgroup$ – Alex C Oct 7 '18 at 18:29
$\begingroup$ So it would be wrong to regress the index levels against each other using Vector Autoregression? $\endgroup$ – DBE7 Oct 7 '18 at 18:35
1

$\begingroup$ @DBE7 That depends on whether the processes are cointegrated. If the two processes are both integrated of order 1 and cointegrated, then regressing one on the other can recover the cointegrating vector with super-consistent convergence. But if they're not cointegrated, you'll get a spurious result (if you mistakenly assume regular OLS assumptions). $\endgroup$ – Matthew Gunn Oct 8 '18 at 21:30

add a comment |

0 Your Answer

Sign up or log in

Post as a guest

Name

Required, but never shown

Post as a guest

Name

Required, but never shown

By clicking "Post Your Answer", you acknowledge that you have read our updated terms of service, privacy policy and cookie policy, and that your continued use of the website is subject to these policies.

asked	3 months ago
viewed	71 times

Stack Exchange Network

current community

your communities

more stack exchange communities

Why does computing correlation between index levels vs. percentage changes yield completely different results?

0

Your Answer

Browse other questions tagged equities time-series statistics forecasting or ask your own question.

Hot Network Questions

Why does computing correlation between index levels vs. percentage changes yield completely different results?

0

Know someone who can answer? Share a link to this question via email, Twitter, or Facebook.

Your Answer

Sign up or log in

Post as a guest

Browse other questions tagged equities time-series statistics forecasting or ask your own question.

Related

Hot Network Questions