How is correlation between two assets typically measured?

Correlation between two assets is typically measured using the Pearson correlation coefficient. This statistical measure quantifies the degree to which two variables move in relation to each other, which is essential in finance for understanding how assets interact in a portfolio. A correlation coefficient can range from -1 to 1, where -1 indicates a perfect negative correlation, 0 indicates no correlation, and 1 indicates a perfect positive correlation.

This measure allows investors and analysts to assess the relationships between asset returns, aiding in portfolio diversification and risk management. The Pearson correlation coefficient is favored due to its straightforward calculation involving the covariance of the asset returns and the standard deviations of each asset.

The other options do not quantify correlation in the same manner. For instance, using a rate of return provides insight into asset performance but does not directly measure the relationship between two assets. The price-to-earnings (P/E) ratio is a valuation metric that compares a company's current share price to its earnings per share, offering insights into valuation rather than correlation. The Sharpe ratio measures the risk-adjusted return of an asset but does not quantify how two assets move together. Thus, the Pearson correlation coefficient is the appropriate choice for measuring correlation between assets.