Nonlinear Relationships between Oil Prices and Implied Volatilities: Providing More Valuable Information

• Main Authors: Jeng-Bau Lin, Chin-Chia Liang, Wei Tsai
• Format: Article
• Language: English
• Published: MDPI AG 2019-07-01
• Series: Sustainability
• Subjects: short-term speculative spread; fear gauge; global political and economic events; multiple structural changes; linear granger causality test; nonlinear granger causality test
• Online Access: https://www.mdpi.com/2071-1050/11/14/3906

This paper investigates the linear/nonlinear long-run and short-run dynamic relationships between oil prices and two implied volatilities, oil price volatility index (OVX) and stock index options volatility index (VIX), representing panic gauges. The results show that there is a long-run equilibrium relationship between oil prices and OVX (VIX) using the linear autoregressive distributed lag (ARDL)-bounds test. Likewise, while using the nonlinear autoregressive distributed lag (NARDL)-bounds test, not only does a long-run equilibrium relationship exist, but also the rising OVX (VIX) has a greater negative influence on oil prices than the declining OVX (VIX), thus indicating that a long-run, asymmetric cointegration exists between the variables. Furthermore, OVX (VIX) oil prices have a linear Granger causality, while for the nonlinear Granger causality test, oil prices have a bidirectional relation with OVX (VIX). In addition, we find that once major international political and economic events occur, structural changes in oil prices change the behavior of oil prices, and thus panic indices, thereby switching from a linear relationship to a nonlinear one. The empirical results of this study provide market participants with more valuable information.