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

Bank of Canada Working Paper No. 2006-31

26 Pages Posted: 15 Mar 2006 Last revised: 31 Oct 2008

See all articles by Antonio Diez de los Rios

Antonio Diez de los Rios

Bank of Canada

René Garcia

Université de Montréal - CIREQ - Département de sciences économiques; University of Montreal

Date Written: October 2008

Abstract

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 non-linear features with the returns on any selected benchmark index. 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 contingent claim features, and test whether the identified non-linear features have a positive value. We find that not all indexes for categories of funds exhibit significant non-linearities, and that only a few strategies as a group provide significant value to investors. Our methodology helps identify individual funds that provide value in an otherwise poorly performing category.

Keywords: Hedge Funds, Nonlinear Returns Structure, Valuation of Contingent Claims, Performance of Hedge Funds

JEL Classification: C1, C5, G1

Suggested Citation

Diez de los Rios, Antonio and Garcia, René, Assessing and Valuing the Non-Linear Structure of Hedge Fund Returns (October 2008). Bank of Canada Working Paper No. 2006-31, Available at SSRN: https://ssrn.com/abstract=890739 or http://dx.doi.org/10.2139/ssrn.890739

Antonio Diez de los Rios

Bank of Canada ( email )

234 Wellington Street
Ottawa, Ontario K1A 0G9
Canada

René Garcia (Contact Author)

Université de Montréal - CIREQ - Département de sciences économiques ( email )

C.P. 6128, succursale Centre-Ville
3150, rue Jean-Brillant, bureau C-6027
Montreal, Quebec H3C 3J7
Canada
514-985-4014 (Phone)

University of Montreal ( email )

United States

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