Optimal Liquidation in Dark Pools
Humboldt University of Berlin
AHL (Man Investments); University of Oxford - Oxford-Man Institute of Quantitative Finance
April 13, 2012
EFA 2009 Bergen Meetings Paper
We consider a large trader seeking to liquidate a portfolio using both a transparent trading venue and a dark pool. Our model captures the price impact of trading in transparent traditional venues as well as the execution uncertainty of trading in a dark pool. The unique optimal execution strategy uses both venues continuously. The order size in the dark pool can over- or underrepresent the portfolio size depending on adverse selection, the correlation structure of the assets in the portfolio and the matching rule. Introduction of a dark pool results in delayed trading at the traditional venue. The appeal of the dark pool is increased by liquidity but reduced by adverse selection. If future returns depend on historical dark pool liquidity, then sending orders to the dark pool can be worthwhile simply to gather information. By pushing up prices at the traditional venue and parallel selling in the dark pool, a trader might generate profits; we provide sufficient conditions to rule out such profitable price manipulation strategies.
Number of Pages in PDF File: 74
Keywords: Dark pools, Optimal liquidation, Adverse selection, Market microstructure, Illiquid markets
JEL Classification: C02, C61, G11, G12, G20working papers series
Date posted: February 17, 2009 ; Last revised: April 18, 2012
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