Strategic Informed Trading and Dark Pools

Abstract

We analyze how a large informed trader chooses between a lit exchange and a dark pool. We show that (1) the market share of the dark pool increases when the informed trader trades; (2) the market share of the dark pool increases more when the value of information is higher; and (3) price discovery decreases with the value of information. We find empirical support for these predictions using trades from activists reported in Schedule 13D filings. A one-standard-deviation increase in the value of an activist’s information increases the dark pool’s market share by 5.8% and reduces price discovery by 9.7%.

Keywords: Dark pool, rational expectations equilibrium, price discovery, shareholder activism, Schedule 13D filings

JEL Classification: G12, G34