City Goes Dark: Dark Trading and Adverse Selection in Aggregate Markets
49 Pages Posted: 16 Aug 2016 Last revised: 3 May 2018
Date Written: August 1, 2017
We present the first evidence of the impact of dark trading on adverse selection in an aggregate market. At moderate levels of dark trading, a positive liquidity effect dominates an information acquisition disincentive effect, such that dark trading induces reductions in both adverse selection risk and pricing noise, while enhancing liquidity. However, there is a trading value-based threshold when dark trading starts to induce adverse selection. We estimate this threshold to vary between 9% for the most liquid FTSE350 index stocks to 35% for the least liquid stocks in the index. The overall FTSE 350 index average threshold is 16%.
Keywords: dark pools, aggregate markets, adverse selection, market liquidity, pricing noise
JEL Classification: G10, G14, G15
Suggested Citation: Suggested Citation