medium · Market Microstructure spread-econ
The Amihud illiquidity ratio is defined as the average of |r_t|/Vol_t (absolute return over dollar volume). A researcher finds that for a given stock, Amihud illiquidity rises sharply during a period when the bid-ask spread, depth, and price-impact coefficient are all UNCHANGED, while average daily dollar volume falls by half and absolute returns are stable.
What does this episode reveal about interpreting Amihud as a liquidity measure?
- Amihud conflates price impact with volume level, so a drop in volume mechanically raises the ratio even when the true cost of trading a fixed quantity is unchanged
- Amihud correctly flags worse liquidity here, since falling volume always signals wider spreads and higher impact even when both are separately measured as flat
- The episode shows Amihud is robust to volume shifts, since a stable impact coefficient guarantees by construction that the ratio cannot move when volume changes
- Amihud measures the realized spread rather than effective spread, so with depth and spread both unchanged the rise must reflect a data error, not liquidity
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