The Rise of the Dark Side; Dark Pool Trading and the Two-Tiered Implication

Abstract

The United States equity market is made up of both private and public trading venues, creating a framework dark and light trading liquidity. Private or non-publicly visible liquidity is housed in dark venues while liquidity visible to the public sits in light locations. Light markets follow strict real-time public reporting requirements for trade volume and price; their dark counterparts execute transactions without a real-time reporting requirement. The informational asymmetries that result from this difference in reporting create a “two-tiered” market. The dark sector’s participants know both the public and dark, private, trade volumes and price, while the public participating in the light market knows only the publicly reported light sector volume and price information. Dark sector participants, institutional investors, then participate in the market using both private and public information, whereas the public investor only has access to the public information. This project seeks to motivate a real-time reporting requirement for trade volume and price in the dark sector of the market in order to remedy this public versus private asymmetry.The informational parameters in this thesis are only those relating to the trades taking place and their respective volumes and prices, not other outside of the market or participant specific informational parameters commonly used in the study of informational asymmetries. This project is an attempt to bridge both the legal aspects and economic foundations relating to the issues surrounding dark sector reporting. Sections I through IV seek to detail the sector and its regulation while sections V through VII briefly describe the related economic literature and the simple model at the heart of this thesis. Additional relevant citations on many issues outside the narrow breadth of this project can be found in the appendices and bibliography.