Mandatory Price Improvement in Dark Pools

58 Pages Posted: 18 Sep 2015 Last revised: 6 Jul 2016

Michael Brolley

Wilfrid Laurier University

Date Written: July 5, 2016

Abstract

Dark pools — trading venues with non-displayed liquidity — fill orders at an improvement on the prevailing displayed quote, but execution is uncertain. I develop a model of informed trading to study how price improvement for dark orders impacts order flow segmentation across a visible limit order market and a dark pool. The impact of dark trading on market quality depends on the relative price improvement of dark orders over limit orders: a larger (smaller) price improvement for dark orders improves (worsens) market quality and welfare. Dark liquidity supply is zero for any price improvement to the midpoint or greater. Price efficiency worsens with any level of dark trading.

Keywords: dark trading, limit order book, informed trading, regulation

JEL Classification: G12, G14, G18

Suggested Citation

Brolley, Michael, Mandatory Price Improvement in Dark Pools (July 5, 2016). Available at SSRN: https://ssrn.com/abstract=2661722 or http://dx.doi.org/10.2139/ssrn.2661722

Michael Brolley (Contact Author)

Wilfrid Laurier University ( email )

Frank Peters Building
75 University Avenue
Waterloo, Ontario N2L 3C5
Canada

HOME PAGE: http://www.mikerostructure.com

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