Hedge fund
Hedge fund investors use serial correlation to detect smoothing in hedge fund returns. Market frictions such as transaction costs and information processing costs that cannot be arbitraged away lead to serial correlation, as well as do stale prices for illiquid assets. Managed prices are a more nefarious cause for serial correlation. Confronted with illiquid, hard to price assets, managers may use some leeway to arrive at the fund’s NAV. When returns are smoothed by marking securities conservatively in the good months and aggressively in the bad months a manager adds serial correlation as a side effect. The more liquid the fund's securities are, the less leeway the manager has to make up the numbers.