Robust Assessment of Hedge Fund Performance Through Nonparametric Risk Adjustment

Abstract

We evaluate the performance of hedge funds through a new nonlinear risk adjustment of returns that captures the nonlinear exposure of a hedge fund strategy to several risk factors and is not limited to option-like shapes. We apply this methodology to various hedge fund indices as well as individual hedge funds, considering a set of risk factors including equities, bonds, credit, currencies and commodities. We report sizable differences in performance between the linear and the nonlinear risk adjustments. Most often the nonlinear risk adjustment reduces the performance but for some strategies it enhances their performance because of their insurance value.