Finance Junkie
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Postby » Wed Mar 20, 2013 1:39 am

For two (possibly dependent) random variables, X and Y, an upper bound on the covariance of X and Y is:

A) 1.
B) σ(X) • σ(Y).
C) there is no upper bound unless the variables are independent.
D) zero.

Can you please explain the answer

Finance Junkie
Posts: 356
Joined: Wed Apr 11, 2012 11:26 am


Postby content.pristine » Thu Mar 21, 2013 11:19 am

Answer is B.
Think about this question as: Cov(x,y)/(σ(X) • σ(Y)) = Correlation(x,y)
now, the range of correlation is (-1 to 1) so, the maximum value is 1.
So if correlation = 1, then cov(x,y)=σ(X) • σ(Y)

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