Modelling the joint dynamics of oil prices and investor fear gauge

• The relationship between WTI returns and crude oil volatility index (OVX) is analysed.
• The direction, dynamics, magnitude and asymmetry of their relationship are modelled.
• The contemporaneous relationship between the OVX and WTI is negative and asymmetric.
• There is a unidirectional causality in-mean from WTI returns to the changes in OVX.
• OVX is verified as a gauge of investor fear for oil prices decrease.

This paper investigates the interdependent relationship between WTI returns and the newly published crude oil volatility index (OVX), combining a cross-correlation function approach, a time-varying parameter (TVP) GARCH model, and a multivariate regression analysis, by which the direction, dynamics, magnitude and asymmetry of their relationship are modelled. At the same time, the implied volatility indexes in the stock market and the gold market are considered for comparison. It is found that there is a significant unidirectional causality-in-mean from WTI returns to the OVX changes, while causality-in-variance from the OVX changes to WTI returns is also significant. The contemporaneous relationship between the OVX changes and WTI returns is significantly negative, and their asymmetric relationship implies that OVX has played a greater role as a gauge of investor fear than as risk preference. The time-varying results indicate that the relationship between the changes in OVX and WTI returns is not always negative.