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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.
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