Abstract
Both theory and evidence are mixed regarding the impact on prices of trading on “dark” venues partially exempt from National Market System requirements. Theory predicts that price discovery improves as dark venues siphon noisy uninformed trades, but increased adverse selection reduces liquidity. Empirical studies, which focus on intraday inefficiency, also find contradictory results. We extend that literature to investigate the impact of dark trading on a longstanding inefficiency based on underreaction to quarterly earnings. We study a randomized controlled trial created by the “trade-at” rule of the SEC’s Tick Size Pilot Program that exogenously shocks dark trading. We supplement that with OLS and 2SLS regressions on a more representative Compustat/CRSP sample. All our results suggest that underreaction increases with dark trading, consistent with reduced liquidity limiting arbitrage. We contribute to the literatures on dark trading and inefficient processing of accounting disclosures, highlighting the role of advances in trading technology.
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