Does OVX affect WTI and Brent oil spot variance? Evidence from an entropy analysis

This paper examines the flow of information and its direction between the oil volatility index (OVX) and the spot variance of WTI and Brent returns. Since OVX is an indicator of the investor sentiment about oil market performance, we aim first at evidencing whether there is an exchange of information between OVX and the spot variance of the two crudes. Moreover, since OVX is linked to WTI crude oil, it is useful to investigate whether it shares an information content with Brent. To this purpose, we propose an entropy-based approach which exploits two non-parametric methods: the mutual information and the transfer entropy. The results show an increase in the information flow between OVX and the spot variance of Brent returns and a corresponding decrease in the information flow with WTI. Furthermore, the direction of the information flow comes from OVX to both oil spot variances, thus investor sentiment about oil market performance drives uncertainty in the corresponding spot market. However, the information flow from the oil spot variances to OVX is more statistically significant for WTI than for Brent and, since transfer entropy is a measure of resolution of uncertainty, we demonstrate that the spot variance of WTI returns helps more in reducing uncertainty about OVX (than Brent).