I'm struggling :-/ between the concept of positive autocorrelation and hedge fund liquidity. Appreciate that you can give some helping hand on it.

1) I understand that a positive autocorrelation, which is characterized by a positive and significant beta coefficient in fund return regression on its own lagged value, implies that the fund returns exhibit a trend. A upward return movement will be followed by another upward return movement and conversely for downward return movement.

2) I also read from some readings that hedge fund illiqudity risk can be represented by a positive first-order autocorrelation as well.

So to me, it seems a hedge fund which is perfectly liquid but simply exhibiting upward trend and a hedge fund which is illiquid will both have positive autocorrelation. Is this correct? and if yes, it's really quite confusing to me because

first of all, I can't link positive autocorrelation to liquidity, understanding that simply uptrend fund also have positive autocorrelation. I also don't understand why less frequent market to market or less liquid price will contribute to positive autocorrelation.

second of all, my first intuition tells me that 1) and 2) shouldn't coexist because in the case when an analayst is analyzing a fund return that has positive autocorrelation, it will become a totally subjective exercise left to the analyst to decide whether it is due to uptrend or to poor liquidity.

Thank you very much!

Cheers

Liming

8/10/2009