Quantile Dependence between Crude Oil Returns and Implied Volatility: Evidence from Parametric and Nonparametric Tests

We examine the daily dependence and directional predictability between the returns of crude oil and the Crude Oil Volatility Index (OVX). Unlike previous studies, we apply a battery of quantile-based techniques, namely the quantile unit root test, the causality-in-quantiles test, and the cross-quantilogram approach. Our main results show evidence of significant bi-directional predictability that is quantile-dependent and asymmetric. A significant positive Granger causality runs from oil (OVX) returns to OVX (oil) returns when both series are in similar lower (upper) quantiles, as well as in opposite quantiles. The Granger causality from OVX returns to oil returns is only significant during periods of high volatility, although it is not always positive. The findings imply that the forward-looking estimate of oil volatility, reflecting the sentiment of oil market participants, should be considered when studying price variations in the oil market, and that crude oil returns can be used to predict oil implied volatility during bearish market conditions. Therefore, the findings have implications regarding predictability under various conditions for oil market participants.

Automated summary

Using quantile-based techniques, we investigate the daily dependence and directional predictability between crude oil returns and the Crude Oil Volatility Index (OVX). Our results reveal significant and quantile-dependent bi-directional predictability that exhibits asymmetry. When both series are in similar lower (upper) quantiles or opposite quantiles, there is a significant positive Granger causality from oil (OVX) returns to OVX (oil) returns. The Granger causality from OVX returns to oil returns is significant during high volatility periods, but not always positive. These findings highlight the importance of considering the forward-looking estimate of oil volatility and using crude oil returns to predict oil implied volatility in bearish market conditions.