Spanning tests for assets with option-like > payoffs: The case of hedge funds

We draw on the skewness literature to propose regression-based performance evaluation tests designed for investments with option-like returns. These tests deliver conclusions valid for all risk-averse mean-variance-skewness investors and can better account for non-linearities in returns than option-based factor models. Applied to mutual funds and hedge funds, our tests usually suggest selecting different funds than standard tests, and find that a significant fraction, 11%, of hedge funds add value to investors, whereas this is an insignificant 4% for mutual funds. We also analyze the economic significance of these option-like returns, and their out-of-sample persistence.