Crashing in the Dark? Dark Trading and Stock Price Crashes

57 Pages Posted: 9 Aug 2022 Last revised: 9 Nov 2023

See all articles by Bidisha Chakrabarty

Bidisha Chakrabarty

Saint Louis University - Richard A. Chaifetz School of Business

Kenneth W. Shaw

University of Missouri at Columbia - School of Accountancy

Xu (Frank) Wang

Saint Louis University - Chaifetz School of Business

Date Written: November 8, 2023

Abstract

Equity trading volume is increasingly moving from stock exchanges to off-exchange dark venues. Theory provides opposing predictions about the association between dark trading and stock price crash risk. Arbitrage cost arguments predict a positive relation, while the price efficiency theory predicts a negative relation. Our results support the former: Dark trading significantly increases stock price crash risk. This result is economically meaningful and robust to using an exogenous shock to dark trading to address endogeneity concerns. Further, in the weeks of and after a stock price crash, abnormal trading volume and trade size increases on dark venues, and this effect is greater for stocks with higher institutional ownership and worse earnings news in the crash week. This suggests that informed traders migrate to dark venues during stock price crashes. In sum, this study introduces a novel feature—extreme negative stock returns—from dark pool trading, and also contributes to a nascent literature on the consequences of stock price crashes. Our results also have potential regulatory implications: By facilitating the separation of informed and uninformed traders, dark markets incentivize managerial withholding of bad news, which increases stock price crash risk.

Keywords: Dark trading, Stock price crash risk, Informed trading, Institutional ownership

JEL Classification: G10, G14, M41

Suggested Citation

Chakrabarty, Bidisha and Shaw, Kenneth W. and Wang, Xu (Frank), Crashing in the Dark? Dark Trading and Stock Price Crashes (November 8, 2023). Available at SSRN: https://ssrn.com/abstract=4181419 or http://dx.doi.org/10.2139/ssrn.4181419

Bidisha Chakrabarty (Contact Author)

Saint Louis University - Richard A. Chaifetz School of Business ( email )

3674 Lindell Blvd
St. Louis, MO MO 63108-3397
United States
3149773607 (Phone)
3149771479 (Fax)

HOME PAGE: http://business.slu.edu/departments/finance/faculty-staff/bidisha-chakrabarty

Kenneth W. Shaw

University of Missouri at Columbia - School of Accountancy ( email )

420 Cornell Hall
Columbia, MO 65211
United States
573-882-5939 (Phone)
573-882-2437 (Fax)

Xu (Frank) Wang

Saint Louis University - Chaifetz School of Business ( email )

3674 Lindell Blvd
St. Louis, MO 63108-3397
United States

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