Information and Optimal Trading Strategies with Dark Pools
60 Pages Posted: 5 Jul 2017 Last revised: 2 Mar 2020
Date Written: November 1, 2017
This paper examines the competition between two trading venues with different degrees of transparency - an exchange organized as a limit order book and an opaque dark pool - in the presence of asymmetric information. We show that the addition of a dark pool that competes with an exchange not only increases traders' strategy set, but may also induce trading venue substitution, a change in the order type, and an increase in market participation compared to when the dark pool is unavailable. Consequently, dark trading affects market quality and traders' profits and its impact depends on stock market characteristics (volatility, liquidity, and adverse selection) and traders' characteristics (immediacy and information). Our model reconciles the ambiguous effects of dark pools on market performance found in previous theoretical and empirical studies and yields new empirical and policy implications.
Keywords: trading venues, dark liquidity, limit order book, price risk, adverse selection
JEL Classification: G12, G14, G18
Suggested Citation: Suggested Citation