Introduction

The Amihud (2002) paper is a seminal work in the field of financial economics that introduced a new measure of illiquidity. This measure, often referred to as the “Amihud Illiquidity Ratio”, is calculated as the average ratio of absolute stock return to its trading volume. The paper demonstrated that this measure can effectively capture the price impact of trading, which is a key aspect of market liquidity.

The paper’s findings have significant implications for asset pricing. It showed that stock illiquidity and the illiquidity risk are priced in the stock market, and they can explain the cross-sectional variations in expected stock returns. This means that stocks with higher illiquidity levels or higher exposure to systematic liquidity risk tend to have higher expected returns as compensation for the higher risk.

 

The Illiquidity measure

Stock illiquidity is defined as the average ratio of the daily absolute return to the (dollar) trading volume on that day, |R_{iyd}| / VOLD_{iyd} where R_{iyd} is the return on stock i on day d of year y and VOLD_{iyd} is the respective daily volume in dollars. This ratio gives the absolute (percentage) price change per dollar of daily trading volume, or the daily price impact of the order flow.

ILLIQ_{iy} = \dfrac{1}{D_{iy}} \sum_{t=1}^{Diy} \dfrac{|R_{iyd}|}{VOL_{ivyd}}  

where D_{iy}  is the number of days for which data are available for stock i in year y

 

Our Stata Code Implementation

We have developed a comprehensive Stata code that replicates the methodology used in Amihud’s paper. Our code covers the following analyses:

  •  ILLIQ: The Amihud illiquidity measure
  •  Creating the variables reported in Table 1 of the paper
  • Construction of Table 1
  • Creating the variables of Table 2
  • Construction of Table 2

Our Stata code is designed to be user-friendly and easy to understand, even for those who are new to Stata. We provide clear comments and explanations for each part of the code to ensure that you can follow along and understand exactly what is happening at each step.

 

benefit of the package content integration Pricing

We offer the code for the first two tables of the paper for 149 GBP.

 

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Dr. Attaullah Shah
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