What is R Squared (R2)?

//What is R Squared (R2)?
What is R Squared (R2)? 2017-10-10T02:20:21+00:00

Definition: R squared, also called coefficient of determination, is a statistical calculation that measures the degree of interrelation and dependence between two variables. In other words, it is a formula that determines how much a variable’s behavior can explain the behavior of another variable.

What Does R Squared Mean?

What is the definition of r squared? Coefficient of determination is widely used in business environments for forecasting procedures. This notion is associated with a statistical model called line of regression, which determines the relationship of independent variables with a dependent variable (the forecasted variable) to predict its behavior. The R-squared formula measures the degree in which the independent variables explain the dependent one.

R-squared coefficients range from 0 to 1 and can also be expressed as percentages in a scale of 1% to 100%. A measure of 70% or more means that the behavior of the dependent variable is highly explained by the behavior of the independent variable being studied. Additionally, the coefficient of determination can be measured per-variable or per-model. This will allow the person handling the statistical projection to understand which variables are useful and which should be excluded from the model since they don’t have enough correlation with the dependent variable.

Here’s a practical example.

Example

Market Intelligence Co. is a company that provides market research services for financial services companies. One of the services they provide regularly is technical stock analysis for individual stocks. As part of these analyses, they provide an R-squared calculation for each stock they review to explain its correlation with a given benchmark index such as the S&P 500 or the Dow Jones Industrial Average. What’s the purpose of this calculation for a financial analyst or investor?

As we discussed previously, the R-squared coefficient measures the degree in which a dependent variable is explained by an independent one. In this case, it will be very useful for an investor to understand how a stock price is affected by a metric like inventory turnover or receivables turnover. This way the investors can look at the trends in these metrics to help predict the future stock price.

Summary Definition

Define R-Squared: Coefficient of determination means a statistical measurement of the correlation between two variables.