Let \(X\)
, \(Y\)
and \(Z\)
be random variables.
Suppose that both \(X\)
and \(Y\)
are positively correlated with \(Z\)
.
Are \(X\)
and \(Y\)
positively correlated?
The answer to this question is “not necessarily.”
To see why, let \(\rho\in[1,1]\)
be a constant, and define the random variables
$$X=\rho Z+W \tag{1}$$
and
$$Y=\rho ZW \tag{2}$$
with \(Z\sim N(0,1)\)
and \(W\sim N(0,1\rho^2)\)
.^{1}
Then \(W\)
, \(X\)
, \(Y\)
and \(Z\)
have zero means, while \(X\)
, \(Y\)
and \(Z\)
have unit variances.
It follows that
$$\begin{align} \newcommand{\E}{\mathrm{E}} \newcommand{\Corr}{\mathrm{Corr}} \newcommand{\Cov}{\mathrm{Cov}} \newcommand{\Var}{\mathrm{Var}} \Corr(X,Y) &= \frac{\Cov(X,Y)}{\sqrt{\Var(X)}\sqrt{\Var(Y)}} \\ &= \Cov(X,Y) \\ &= \E[XY]\E[X]\E[Y] \\ &= \E[XY], \end{align}$$
and similarly \(\Corr(X,Z)=\E[XZ]\)
and \(\Corr(Y,Z)=\E[YZ]\)
.
Now
$$\begin{align} \E[XZ] &= \E[(\rho Z+W)Z] \\ &= \rho\E[Z^2]+\E[WZ] \\ &= \rho\Var(Z)+\rho\E[Z]^2+\Cov(W,Z)+\E[W]\E[Y] \\ &= \rho \end{align}$$
because \(W\)
and \(Z\)
are independent.
A similar argument yields \(\E[YZ]=\rho\)
.
Finally, substituting \((1)\)
into \((2)\)
so as to eliminate \(W\)
gives
$$Y=2\rho ZX,$$
from which we obtain
$$\begin{align} \Corr(X,Y) &= \E[XY] \\ &= \E[X(2\rho ZX)] \\ &= 2\rho\E[XZ]\E[X^2] \\ &= 2\rho\E[XZ]\Var(X)+\E[X]^2 \\ &= 2\rho^21. \end{align}$$
Thus, if \(\rho\in(0,1/\sqrt{2})\)
then \(X\)
and \(Y\)
share a negative correlation even though both are correlated positively with \(Z\)
.
Intuitively, if \(\rho\)
is sufficiently small then the negative correlation between the error terms \(W\)
and \(W\)
dominates the positive correlations between \(X\)
and \(Z\)
, and \(Y\)
and \(Z\)
.

Here
\(N(\mu,\sigma^2)\)
denotes the normal distribution with mean\(\mu\)
and variance\(\sigma^2\)
. ↩︎