What does the calculation of correlation between two assets require?

The correlation between two assets quantifies the degree to which their returns move in relation to one another. To calculate this correlation, it is essential to consider not only the individual assets but also their relationship to the overall market, which is represented through beta and variances.

Beta is a measure of how much an asset's return is expected to move relative to a change in market return. It is not sufficient to simply use historical prices or average returns, as these do not capture the relationship between the assets adequately without taking market factors into account. The variances of the market and the individual assets provide the necessary context to understand how these assets interact with the market's movements.

Using betas and market variances allows for a more precise calculation of correlation, as this method reflects not just historical performance but also the theoretical risk and return relationship inherent to each asset. Thus, considering betas and market variances facilitates a comprehensive understanding of the correlation dynamics between the two assets.