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Reading academic papers on hedge funds, I find that many authors saying that hedge fund returns are often non-linear and thus many simple quantitative techniques are not suitable. It seems like they make one big assumption that the fund managers can predict the market perfectly so that they long stocks that will perform well and short stocks that will perform poorly so their returns are V-shaped, much like a straddle payoff.

To me, that is a very strong and very unrealistic assumption to make. I am wondering what methods/tests exist to see if a given return stream is linear.

thank you.

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    $\begingroup$ Linear in what? $\endgroup$ – Matthew Gunn Feb 27 at 21:48
  • $\begingroup$ You probably mean that fund returns are similar to payoffs of straddles on SPX. There are many different kinds of funds whose returns have very different statistical properties. Some types of funds (eg CTAs) do have returns with broad similarities to straddles over long horizons but can also exhibit serious drawdowns. Before anyone can answer more generally it would be helpful for you to direct us to the literature to which you are referring. $\endgroup$ – Nick Firoozye Mar 1 at 0:36

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