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Crude oil prices have declined by 58% from June 2014 to January 2015. This sharp negative departure from trend takes place three years after the 2011 collapse of gold prices and the start of the commodities´ bear market which has seen an overall reduction of commodity prices by 46% per cent.
The crude oil market had a sustained pre-crisis run-up in the prices prior to a historical collapse in the midst of the crisis in 2008. The post-crisis data indicates that crude oil enjoyed an important price run-up in 2011 that was then reversed by a downward price adjustment. WTI crude oil prices have since the autumn of 2011 oscillated around the $100 level and traded at very low volatility levels. The downward trend in volatility was reverted last summer when a sharp collapse in prices placed the CBOE crude oil VIX, the volatility measure based on WTI options US fund, to a multiyear high, reaching levels not seen since the 2008 crisis. Fig 1 plots daily WTI front month futures price levels and the CBOE crude oil VIX which measures the expected volatility of crude and is the benchmark for the degree of risk aversion in the crude oil perceived in the market. A close inspection of the graph shows that the three most significant downward crude oil price adjustments seen over the last decade have been accompanied by a dramatic rise in CBOE oil volatility. Indeed the correlation coefficient between front month daily NYMEX WTI crude future prices and the CBOE crude oil VIX over the past eight years is equal to -0.55. This underlies the strong relationship between volatility and market performance. Volatility tends to decline as the market rises and increase as the market falls. When volatility increases, risk increases and returns decrease. During the recent crude oil price collapse, the CBOE Implied crude oil VIX has moved from an all-time low of 15% in the spring of 2009 to a six year maximum on February the 5th indicating that traders remain in panic and at edge about the market. An important question that arises is the extent to which forward looking volatility measures market fundamentals, which we assess by looking at crude oil´s tem structure of prices.
The oil price has reached a five-month high, with WIT oil futures breaking through the $55 per barrel level for the first time this year at the same time as the benchmark for crude oil volatility drops to 37 volatility points, reaching levels not seen since December 2014. Changes in crude oil price and volatility can be justified in terms of supply fundamentals namely the fall in US oil rigs, the slowdown of crude oil inventory build in the US, and increased concerns regarding the conflict in the Middle East. The recent run up in prices has led to renewed optimism in the energy sector. The main question for traders now is whether the period of bearish prices and increasing volatility is coming to an end.
Disagreement about the future direction of the oil price is emerging as energy traders take positions in the hope of a quick recovery under expectations of tighter global oil balances, while the industry is preparing for an extended period of low prices and cost-cutting. It is therefore important to establish what market measure can be used by market participants on a daily basis to measure uncertainty in the crude oil market. The perceived gauge of risk aversion in the crude oil market can be captured by the the CBOE Crude Oil ETF. In what follows, we show that the changes in the crude oil VIX can be modelled using GARCH volatility estimates of NYMEX (1 month) WTI futures. The crude oil VIX and GARCH volatility estimates may be considered jointly to improve volatility predictability and to quantify the relative efficiency of the two measures in incorporating new information.
Are correlations across assets constant for every time interval?
Let´s analyze this question taking two series in the energy sector: kerosene and crude oil prices.