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Assessing and valuing the nonlinear structure of hedge fund returns
Author(s) -
Diez De Los Rios Antonio,
Garcia René
Publication year - 2011
Publication title -
journal of applied econometrics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 2.878
H-Index - 99
eISSN - 1099-1255
pISSN - 0883-7252
DOI - 10.1002/jae.1147
Subject(s) - returns based style analysis , hedge fund , portfolio , econometrics , equity (law) , economics , valuation (finance) , nonlinear system , financial economics , actuarial science , performance fee , statistical hypothesis testing , open end fund , mathematics , finance , statistics , institutional investor , corporate governance , physics , quantum mechanics , political science , law
Several studies have put forward that hedge fund returns exhibit a nonlinear relationship with equity market returns, captured either through constructed portfolios of traded options or piece‐wise linear regressions. This paper provides a statistical methodology to unveil such nonlinear features with respect to returns on benchmark risk portfolios. We estimate a portfolio of options that best approximates the returns of a given hedge fund, account for this search in the statistical testing of the nonlinearity, and provide a reliable test for a positive valuation of the fund. We find that not all fund categories exhibit significant nonlinearities, and that only a few strategies provide significant value to investors. Our methodology helps identify individual funds that provide value in an otherwise poorly performing category. Copyright © 2010 John Wiley & Sons, Ltd.