Reading 11, 3.4 Coefficient of Determination - Method 1

Level 2, Volume 1, Quantitative Methods, Reading 11, Correlation & Regression

The references refer to the CFA text book.

3.4 Coefficient of determination (“CD”)

Why CD?

The standard error of estimate (SEE) gives some indication of how certain one can be about a particular prediction of Y using the regression equation.

It does not tell us how well the independent variable explains variation in the dependent variable. The coefficient of determination does this, measuring the fraction of the total variation in the dependent variable that is explained by the independent variable.

There are 2 methods to calculate CD, method 1 is shown below, with Method 2 in the next post

Method 1:  For use in a linear regression with ONE independent variable

CD = Square the correlation coefficient between the dependent and independent variables.

(Link to Excel file on box.net)

Example

1. Data
Year	2010	2009		2008		2007		2006
Revenue US $m	52798	50211		59473		47473		39099
Earnings per ordinary share - declared in respect of the period (US sent)	227.8	105.4		274.8		228.9		172.4

2. Calculation
Coefficient Correlation			0.51
Square the CC			(0.51)X(0.51)
Coefficient of determination			0.26