Gudjohnsen was poised to join West Ham on a one-year deal after passing a medical at Upton Park earlier this week.
The 32-year-old is available on a free transfer after leaving Stoke earlier this summer and Allardyce was keen to be reunited with the Iceland international having worked with him during his time in charge of Bolton.
However, Greek side AEK Athens are thought to have entered the chase for Gudjohnsen and Allardyce has decided to end his interest in the player after he hesitated in signing the deal on offer at Upton Park.
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