The dynamic interrelations of oil-equity implied volatility indexes under low and high volatility-of-volatility risk

Abstract

This study employs the Markov-switching vector correction model (MRS-VECM), in which the magnitude of cointegration and correlation are conditional on the regime of the volatility of volatility indexes, to examine the dynamic interrelations between the oil-equity volatility indexes. The CBOE crude oil volatility index (OVX) and stock market volatility index (VIX) are used as a proxy of the oil and equity market volatility index, respectively. Our empirical results and their implications are summarized as follows. First, there is a long-run cointegration relationship between OVX and VIX. Adjustments maintaining the relationship take place on OVX, which is evidence that the revelation of investor fears, proxied by the volatility index, is focused on the equity market. Second, the magnitude of cointegration and correlation between the OVX and VIX under the regime of high volatility-of-volatility risk is greater than that at the low risk. These results imply that the fear gauge of oil and equity markets moves in tandem, particularly during times of economic distress and uncertainty.