Module 2: Unit 4

Partial Correlation Coefficients

A partial correlation coefficient measures the relationship between any two variables, when all
other variables connected with those two are kept constant. For example, let us assume that we
want to measure the correlation between the number of hot drinks (X1) consumed in a summer
resort and the number of tourists (X2) coming to that resort. It is obvious that both variables are
strongly influenced by weather conditions, which we may designate by X3. On a-priori grounds
we expect X1 and X2 to be positively correlated: when a large number of tourists arrive in the
summer resort, one should expect a high consumption of hot drinks and vice versa. The
computation of the simple correlation coefficient between X1 and X2 may not reveal the true
relationship connecting these two variables, however, because of the influence of the third
variable, weather conditions (X3). In other words, the above positive relationship between number
of tourists and number of hot drinks consumed is expected to hold if weather conditions can be
assumed constant. If weather condition changes, the relationship between X1 and X2 may change
to such an extent as to appear even negative. Thus, if the weather is hot, the number of tourists will
be large, but because of the heat they will prefer to consume more cold drinks and ice-cream rather
than hot drinks. If we overlook the weather and look only at X1 and X2 we will observe a negative
correlation between these two variables which is explained by the fact that hot drinks as well as
number of visitors are affected by heat. In order to measure the true correlation between X 1 and
X2, we must find some way of accounting for changes in X3. This is achieved with the partial
correlation coefficient between X1 and X2, when X3 is kept constant. The partial correlation
coefficient is determined in terms of the simple correlation coefficients among the various
variables involved in a multiple relationship. In our example there are three simple correlation
coefficients
r12 = correlation coefficient between X1 and X2
r13 = correlation coefficient between X1 and X3
r23 = correlation coefficient between X2 and X3
The partial correlation coefficient between X1 and X2, keeping the effect of X3 constant is given
by:

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 r12  r13r23
r12..3  2.4
(1  r13 )(1  r23 )
2 2

Similarly, the partial correlation between X1 and X3, keeping the effect of X2 constant is given by:

r13  r12 * r23 r23  r12 * r13

r13.2  and r23.1 
(1  r12 )(1  r23 )
2 2
(1  r122 )(1  r132 )

Example 3: The following table gives data on the yield of corn per acre(Y), the amount of fertilizer
used(X1) and the amount of insecticide used (X2). Compute the partial correlation coefficient
between the yield of corn and the fertilizer used keeping the effect of insecticide constant.
Table 1: Data on yield of corn, fertilizer and insecticides used
Year 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980
Y 40 44 46 48 52 58 60 68 74 80
X1 6 10 12 14 16 18 22 24 26 32
X2 4 4 5 7 9 12 14 20 21 24

The computations are done as follows:

Table 2: Computation for partial correlation coefficients
Year Y X1 X2 Y x1 x2 x1y x2y x1x2 x12 x22 y2
1971 40 6 4 -17 -12 -8 204 136 96 144 64 289
1972 44 10 4 -13 -8 -8 104 104 64 64 64 169
1973 46 12 5 -11 -6 -7 66 77 42 36 49 121
1974 48 14 7 -9 -4 -5 36 45 20 16 25 81
1975 52 16 9 -5 -2 -3 10 15 6 4 9 25
1976 58 18 12 1 0 0 0 0 0 0 0 1
1977 60 22 14 3 4 2 12 6 8 16 4 9
1978 68 24 20 11 6 8 66 88 48 36 64 121
1979 74 26 21 17 8 9 136 153 72 64 81 289
1980 80 32 24 23 14 12 322 276 168 196 144 529
Sum 570 180 120 0 0 0 956 900 524 576 504 1634
Mean 57 18 12

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 ryx1=0.9854
ryx2=0.9917
rx1x2=0.9725
Then,

ryx1  ryx2 rx1x2 0.9854  (0.9917 )(0.9725 )

ryx1 . x2    0.7023
(1  ryx2 )(1  rx1x2 )
2 2
(1  0.9917 2 )(1  0.9725 2 )

Limitations of the Theory of Linear Correlation

Correlation analysis has serious limitations as a technique for the study of economic relationships.
Firstly: The above formulae for r apply only when the relationship between the variables is linear.
However two variables may be strongly connected with a nonlinear relationship.
It should be clear that zero correlation and statistical independence of two variables (X and Y) are
not the same thing. Zero correlation implies zero covariance of X and Y so that r=0. Statistical
independence of x and y implies that the probability of x i and yi occurring simultaneously is the
simple product of the individual probabilities
P (x and y) = p (x) p (y)
Independent variables do have zero covariance and are uncorrelated: the linear correlation
coefficient between two independent variables is equal to zero. However, zero linear correlation
does not necessarily imply independence. In other words uncorrelated variables may be
statistically dependent. For example if X and Y are related so that the observations fall on a circle
or on a symmetrical parabola, the relationship is perfect but not linear. The variables are
statistically dependent.
Secondly, the second limitation of the theory is that although the correlation coefficient is a
measure of the co-variability of variables, it does not necessarily imply any functional relationship
between the variables concerned. Correlation theory does not establish, and/ or prove any causal
relationship between the variables. It seeks to discover a co-variation exists, but it does not suggest
that variations in, say, Y are caused by variations in X, or vice versa. Knowledge of the value of r,
alone, will not enable us to predict the value of Y from X. A high correlation between variables Y
and X may describe any one of the following situations:
(1) variation in X is the cause of variation in Y,

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 (2) variation in Y is the cause of variation X,
(3) Y and X are jointly dependent, or there is a two- way causation, that is to say Y is the cause
of (is determined by) X, but also X is the cause of (is determined by) Y. For example in
any market: q = f (p), but also p = f(q), therefore there is a two – way causation between q
and p, or in other words p and q are simultaneously determined.
(4) there is another common factor (Z), that affects X and Y in such a way as to show a close
relation between them. This often occurs in time series when two variables have strong
time trends (i.e. grow over time). In this case we find a high correlation between Y and X,
even though they happen to be causally independent,
The correlation between X and Y may be due to chance.