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Assessing and Valuing the Non-Linear Structure of Hedge Fund Returns

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  • Antonio Diez de los Rios
  • René Garcia

Abstract

Several studies have put forward the non-linear structure and option-like features of returns associated with hedge fund strategies. The authors provide a statistical methodology to test for such non-linear features with the returns on any benchmark portfolio. They estimate the portfolio of options that best approximates the returns of a given hedge fund, account for this search in the statistical testing of the contingent claim features, and test whether the identified non-linear features have a positive value. The authors find that not all categories of funds exhibit significant non-linearities, and that only a few strategies as a group provide significant value to investors. Individual funds may still provide value in an otherwise poorly performing category.

Suggested Citation

  • Antonio Diez de los Rios & René Garcia, 2006. "Assessing and Valuing the Non-Linear Structure of Hedge Fund Returns," Staff Working Papers 06-31, Bank of Canada.
    • Handle: RePEc:bca:bocawp:06-31
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    References listed on IDEAS

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    11. Vikas Agarwal, 2004. "Risks and Portfolio Decisions Involving Hedge Funds," Review of Financial Studies, Society for Financial Studies, vol. 17(1), pages 63-98.
    12. Dybvig, Philip H & Ross, Stephen A, 1985. "The Analytics of Performance Measurement Using a Security Market Line," Journal of Finance, American Finance Association, vol. 40(2), pages 401-416, June.
    13. Fung, William & Hsieh, David A, 2001. "The Risk in Hedge Fund Strategies: Theory and Evidence from Trend Followers," Review of Financial Studies, Society for Financial Studies, vol. 14(2), pages 313-341.
    14. Robert B. Davies, 2002. "Hypothesis testing when a nuisance parameter is present only under the alternative: Linear model case," Biometrika, Biometrika Trust, vol. 89(2), pages 484-489, June.
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    Citations

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    Cited by:

    1. Javier Mencía, 2012. "Testing Nonlinear Dependence in the Hedge Fund Industry," Journal of Financial Econometrics, Oxford University Press, vol. 10(3), pages 545-587, June.
    2. Karagiorgis, Ariston & Drakos, Konstantinos, 2022. "The Skewness-Kurtosis plane for non-Gaussian systems: The case of hedge fund returns," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 80(C).
    3. G. Hübner & M. Lambert & N. Papageorgiou, 2015. "Higher†moment Risk Exposures in Hedge Funds," European Financial Management, European Financial Management Association, vol. 21(2), pages 236-264, March.
    4. Andrew W. Lo & Mila Getmansky & Peter A. Lee, 2015. "Hedge Funds: A Dynamic Industry in Transition," Annual Review of Financial Economics, Annual Reviews, vol. 7(1), pages 483-577, December.
    5. Fan Yang & Tomas Havranek & Zuzana Irsova & Jiri Novak, 2022. "Hedge Fund Performance: A Quantitative Survey," Working Papers IES 2022/15, Charles University Prague, Faculty of Social Sciences, Institute of Economic Studies, revised Jun 2022.
    6. Serge Darolles & Christian Gouriéroux, 2013. "The Effects of Management and Provision Accounts on Hedge Fund Returns - Part I : The High Water Mark Scheme," Working Papers 2013-22, Center for Research in Economics and Statistics.
    7. Roncalli, Thierry & Weisang, Guillaume, 2011. "Tracking Problems, Hedge Fund Replication, and Alternative Beta," Journal of Financial Transformation, Capco Institute, vol. 31, pages 19-29.
    8. Darolles, Serge & Gourieroux, Christian, 2010. "Conditionally fitted Sharpe performance with an application to hedge fund rating," Journal of Banking & Finance, Elsevier, vol. 34(3), pages 578-593, March.
    9. Chabi-Yo, Fousseni & Huggenberger, Markus & Weigert, Florian, 2022. "Multivariate crash risk," Journal of Financial Economics, Elsevier, vol. 145(1), pages 129-153.
    10. Szabolcs Blazsek & Anna Downarowicz, 2013. "Forecasting hedge fund volatility: a Markov regime-switching approach," The European Journal of Finance, Taylor & Francis Journals, vol. 19(4), pages 243-275, April.
    11. Roumpis, Efthymios & Syriopoulos, Theodore, 2014. "Dynamics and risk factors in hedge funds returns: Implications for portfolio construction and performance evaluation," The Journal of Economic Asymmetries, Elsevier, vol. 11(C), pages 58-77.
    12. Antonio Diez de los Rios & René Garcia, 2011. "The option CAPM and the performance of hedge funds," Review of Derivatives Research, Springer, vol. 14(2), pages 137-167, July.

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    More about this item

    Keywords

    Econometric and statistical methods; Financial institutions;

    JEL classification:

    • C1 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General
    • C5 - Mathematical and Quantitative Methods - - Econometric Modeling
    • G1 - Financial Economics - - General Financial Markets

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