Does Bid-Ask Spread Affect Trading in Exchange Operated Dark Pool: Evidence from a Natural Experiment

Abstract

We exploit the exogenously instituted minimum tick size change to examine the dynamic relation between the bid-ask spread in the lit market and dark trading activity in the exchange operated dark pool in Japan. Using a difference – in – differences methodology, we document that stocks that are affected by the minimum tick size change have a lower share of trading in the exchange operated dark pool. Overall, our empirical findings provide evidence that a significant amount of dark trading is liquidity seeking. Reducing minimum tick size can help lit venues regain market shares over dark venues.

Keywords: Darking trading, Exchange operated dark pool, Tick size change, Bid-ask spread, Japanese market