PORTFOLIO RETURN AUTOCORRELATION

This paper investigates whether portfolio return autocorrelation can b e explained by time-varying expected returns, nontrading, stale limit orders, market maker inventory policy, or transaction costs. Evidence is consistent with the hypothesis that transaction costs cause portfol io autocorrelation by slowing price adjustment. I develop a transactio n-cost model which predicts that prices adjust faster when changes in valuation are large in relation to the bid-ask spread. Cross-sectional tests support this prediction, but time-series tests do not.