Efficient predictability of oil price: The role of VIX-based panic index shadow line difference

This paper shows that the panic index shadow line difference (ULD) can be an effective predictor of oil returns. We use a candlestick chart to plot the investor panic index (VIX) and subtract the lower shadow from the upper shadow to obtain ULD. The in-sample analysis shows that the ULD can significantly and negatively predict oil returns. The out-of-sample results show that the inclusion of ULD, an exogenous regression variable, in the model not only substantially improves the predictive accuracy of oil returns, but also yields good economic benefits when using its predicted values for portfolio investment. All bivariate regression models that include ULD as an exogenous regression variable obtain higher prediction accuracy than univariate regression models, both for insample and out-of-sample predictions. All the robustness tests done in this paper show that ULD is a powerful predictor that significantly improves the predictability of oil returns.