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Assessing and valuing the nonlinear structure of hedge fund returns

  • Antonio Diez De Los Rios
  • René Garcia

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 (C) 2010 John Wiley & Sons, Ltd.

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File URL: http://hdl.handle.net/10.1002/jae.1147
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Article provided by John Wiley & Sons, Ltd. in its journal Journal of Applied Econometrics.

Volume (Year): 26 (2011)
Issue (Month): 2 (March)
Pages: 193-212

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Handle: RePEc:wly:japmet:v:26:y:2011:i:2:p:193-212
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