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Don't Confuse Correlation and Causation

Economic reasoning must be a part of finding causation, not just statistical links.

Paul Kaplan: Quoting Benjamin Disraeli, Mark Twain famously quipped, "There are three kinds of lies: lies, damned lies, and statistics." In the field of investments, in which we rely heavily on statistical analysis to evaluate the merits of numerous investment strategies and products, Twain's point is all too relevant.

One statistic that is all too easy to be misleading is correlation, starting with its definition. How many times have we heard that correlation measures the tendency for two variables to move up and down together? That's not quite right. What correlation actually measures is the degree to which two variables, each in excess of its own average, are statistically related.