Dark Pools and Price Discovery in Limit Order Markets
Posted: 2 Aug 2021 Last revised: 16 Dec 2022
Date Written: July 4, 2021
This paper examines how the introduction of a dark pool impacts price discovery, market quality, and aggregate welfare of traders. I use a four-period model where rational and risk-neutral agents choose the order type and the venue and obtain the equilibrium numerically. The comparative statics on the order submission probability suggests a U-shaped order migration to the dark pool. The overall effect of dark trading on market quality and aggregate welfare was found to be positive but limited in size and depended on market conditions. I find mixed results for the process of price discovery. Depending on the immediacy need of traders, price discovery may change due to the presence of the dark venue.
Keywords: Dark pool, limit order book, information asymmetry
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