Thomas is right. One should never measure correlations based on prices-
it always leads to hugely inflated absolute correlations. It is not
uncommon for beginners to take correlations of prices and find, to their
delight, that correlations are as high as 70-90% on some assets. Then,
when they try to use spread option strategies to take advantage of the
tight correlations, they find that their strategies break down because
the actual correlations are only about 30-40%.

On Sat, 2010-02-20 at 18:30 +0100, Thomas Etheber wrote:

> Price time series will usually have a positive drift and thus are 
> non-stationary.
> As far as I know most methods of time series analysis deal with 
> stationary series and if you want to analyze a non-stationary series, 
> you should transform  the series and obtain a stationary version of the 
> raw data first.
> Return time series are usually (or at least assumed to be) stationary 
> and thus your focus should lie on returns rather than prices..
> 
> Hth
> Thomas
> 
> 
> 
> Michael Jungle schrieb:
> > Thx but why? I want buy/short based on price correlations right? Not returns...
> >
> > On Saturday, February 20, 2010, Patrick Burns-2 [via R]
> > <ml-node+1562668-773442928-108803@n4.nabble.com> wrote:
> >   
> >> You want to use returns, not prices.
> >>
> >> Correlations with prices are spurious.
> >>
> >> (The extreme example is to think of
> >>
> >> a long set of series with inflation --
> >>
> >> all the price series will be positively
> >>
> >> correlated.)
> >>
> >>
> >>
> >> On 19/02/2010 23:15, Michael Jungle wrote:
> >>
> >>     
> >>> One possibility is to do the cross-correlation.
> >>>       
> >>> What series shall I apply cross-correlation to? Price or return series?
> >>>       
> >>> If I do cross-correlation on two price series, and found some large
> >>>       
> >>> correlation numbers,
> >>>       
> >>> and then do cross-correlation on two return series, and found no significant
> >>>       
> >>> numbers(almost zero),
> >>>       
> >>> What does that mean?
> >>>       
> >> --
> >>
> >> Patrick Burns
> >>
> >> [hidden email]Â <http://n4.nabble.com/user/SendEmail.jtp?type=node&node=1562668&i=0>
> >>
> >> http://www.burns-stat.com
> >>
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> >>
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> >>
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> >>
> >>
> >>     
> >
> >   
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