58 Pages Posted: 18 Sep 2015 Last revised: 6 Jul 2016
Date Written: July 5, 2016
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: Suggested Citation