Volatility and correlation don’t measure what you think

Two ubiquitous risk analytics are easily and often misunderstood

smoke-volatility

Take a quick look at the two panels of Figure 1 and estimate the correlation for the two funds in both panels. Really, please do it now. What's your gut feel of the correlation of each set? If you are like virtually everyone I asked, it is quite obvious that the two funds in the left panel are uncorrelated or possibly negatively correlated while those in the right panel are highly correlated with each other. Estimates for the left range from zero to -0.7, and estimates for the right panel are

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