Do Dark Pools Harm Price Discovery?

Abstract:     
Dark pools are equity trading systems that do not publicly display orders. Dark pools offer potential price improvements but do not guarantee execution. Informed traders tend to trade in the same direction, crowd on the heavy side of the market, and face a higher execution risk in the dark pool, relative to uninformed traders. Consequently, exchanges are more attractive to informed traders, and dark pools are more attractive to uninformed traders. Adding a dark pool alongside an exchange tends to concentrate price-relevant information into the exchange and improve price discovery. Improved price discovery coincides with reduced exchange liquidity.

Number of Pages in PDF File: 51

Keywords: dark pools, price discovery, liquidity, fragmentation, equity market structure

JEL Classification: G12, G14, G18

working papers series