Gamma Trading Skills in Hedge Funds

This paper explores the gamma trading, timing and managerial skills of individual hedge funds across categories. We replicate the non-linear payoffs of hedge funds with traded options, with the option features being endogenously defined. The framework provides a flexible tool to create a benchmark for the convexity or concavity of hedge fund payoffs through the selection of option features. For 10,958 hedge funds, our framework manages to replicate 30% of the funds at the 10% significance level and up to 42% at the 20% significance level. We globally assign hedge fund styles to three categories: directional with market timing skills, non-directional and market timers. We also estimate the impact of our framework on hedge fund performance and find positive adjustments for market timing skills but negative adjustments for negative timing (short put) and convergence bets (top straddles). The adjustments strongly depend on the curvature of the payoff. Combining our approach with standard option-like factors used in the literature, we observe almost no selection skills for hedge funds over the sample period.