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Can corr(A,C) be 0.1 given the other two

Question

Suppose BB has correlation 0.90.9 with AA and correlation 0.80.8 with CC. Could the correlation between AA and CC be as low as 0.10.1?

Short answer

No. The 3×33\times3 correlation matrix must be positive semi-definite, which forces ρAC∈[0.72−(1−0.81)(1−0.64), 0.72+(1−0.81)(1−0.64)]≈[0.46, 0.98]\rho_{AC}\in\left[0.72-\sqrt{(1-0.81)(1-0.64)},\,0.72+\sqrt{(1-0.81)(1-0.64)}\right]\approx[0.46,\,0.98]. With ρAC=0.1\rho_{AC}=0.1 the determinant is negative.

Adapted from Joshi, Denson & Downes, Quant Job Interview Questions and Answers, Q3.26, p.83; question and answer rewritten by SelfMadeQuant.com.

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