The Amihud illiquidity ratio, introduced in Yakov Amihud's 2002 paper, is a cross-sectional proxy for the price impact of order flow. For a given stock and day it is computed as:
Amihud = |r_t| / DollarVolume_t
where |r_t| is the absolute daily return and DollarVolume_t is the total dollar volume traded. The ratio measures how much a unit of trading volume moves the price — higher values indicate a less liquid stock where the same trade has a larger price impact.
The measure's appeal is its simplicity: it requires only price and volume data, available for any exchange-listed stock over long histories. It correlates well with more sophisticated spread and impact measures derived from order-book data.
Use in alpha research
- Liquidity signals derived from Amihud ratios capture the illiquidity premium — less liquid stocks tend to earn higher expected returns as compensation for bearing liquidity risk.
- As a portfolio construction constraint: stocks with very high Amihud ratios may be excluded or down-weighted when capacity is a concern.
- As a risk factor in attribution: exposure to the illiquidity factor explains part of a strategy's return.