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Covariance is a measure of the volatility inherent in any risk-taking venture or activity.

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It also indicates the manner in which two or more risk profiles react, when combined, to create either greater or lesser overall volatility. If multiple risk profiles are uncorrelated, lower overall volatility may result compared to the individual risk profiles prior to the combination. For example, a book of high-excess property insurance business is not correlated to a group of directors and officers (D&O) liability policies and would therefore produce lower overall volatility if an insurer were to write both types of coverage.

Related Terms

Correlation is the extent to which multiple risk profiles move in relation to each other.