Do Dark Pools Harm Price Discovery?
Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER)
November 16, 2013
Forthcoming, Review of Financial Studies
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. Under certain conditions, adding a dark pool alongside an exchange concentrates price-relevant information into the exchange and improves price discovery. Improved price discovery coincides with reduced exchange liquidity.
Number of Pages in PDF File: 53
Keywords: dark pools, price discovery, liquidity, fragmentation, equity market structure
JEL Classification: G12, G14, G18
Date posted: December 16, 2010 ; Last revised: November 16, 2013