Dark Pools Research Articles

Dark Pools under Different Execution Priority, Adverse Selection and Traders' Competition

Dark Pools under Different Execution Priority, Adverse Selection and Traders' Competition

Does Bid-Ask Spread Affect Trading in Exchange Operated Dark Pool? – Evidence From a Natural Experiment

We exploit the exogenously instituted minimum tick size change to examine the dynamic relationship 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 a significant treatment effect where 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 first-hand 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.

Fixed-Price Approximations to Optimal Efficiency in Bilateral Trade

This paper studies fixed-price mechanisms in bilateral trade with ex ante symmetric agents. We show that the optimal price is particularly simple: it is exactly equal to the mean of the agents' distribution. The optimal price guarantees a worst-case performance of at least 1/2 of the first-best gains from trade, regardless of the agents' distribution. We also show that the worst-case performance improves as the number of agents increases, and is robust to various extensions. Our results offer an explanation for the widespread use of fixed-price mechanisms for size discovery, such as in workup mechanisms and dark pools.

Shorting in Broad Daylight: Short Sales and Venue Choice

Using a novel database on venue short sales and market design characteristics, we ask: Where do short sellers exploit their information advantage? Consistent with the prediction of Zhu (2014), we find that exchange short sales comprise a larger proportion of trading and are more informative about future prices than dark-pool short sales, particularly when there is greater competition among short sellers to trade and in the presence of short-lived information. When examining market design characteristics, we find that dark pools offering volume-weighted average price crossing attract more short sales, whereas those offering block trading attract fewer short sales.

‘Dark pools’ of hate flourish online. Here are four controversial ways to fight them

‘Dark pools’ of hate flourish online. Here are four controversial ways to fight them

Hidden resilience and adaptive dynamics of the global online hate ecology.

Online hate and extremist narratives have been linked to abhorrent real-world events, including a current surge in hate crimes1-6 and an alarming increase in youth suicides that result from social media vitriol7; inciting mass shootings such as the 2019 attack in Christchurch, stabbings and bombings8-11; recruitment of extremists12-16, including entrapment and sex-trafficking of girls as fighter brides17; threats against public figures, including the 2019 verbal attack against an anti-Brexit politician, and hybrid (racist-anti-women-anti-immigrant) hate threats against a US member of the British royal family18; and renewed anti-western hate in the 2019 post-ISIS landscape associated with support for Osama Bin Laden's son and Al Qaeda. Social media platforms seem to be losing the battle against online hate19,20 and urgently need new insights. Here we show that the key to understanding the resilience of online hate lies in its global network-of-network dynamics. Interconnected hate clusters form global 'hate highways' that-assisted by collective online adaptations-cross social media platforms, sometimes using 'back doors' even after being banned, as well as jumping between countries, continents and languages. Our mathematical model predicts that policing within a single platform (such as Facebook) can make matters worse, and will eventually generate global 'dark pools' in which online hate will flourish. We observe the current hate network rapidly rewiring and self-repairing at the micro level when attacked, in a way that mimics the formation of covalent bonds in chemistry. This understanding enables us to propose a policy matrix that can help to defeat online hate, classified by the preferred (or legally allowed) granularity of the intervention and top-down versus bottom-up nature. We provide quantitative assessments for the effects of each intervention. This policy matrix also offers a tool for tackling a broader class of illicit online behaviours21,22 such as financial fraud.

Market quality and dark trading in the post MiFID II era: What have we learned so far?

In this letter, we use the implementation of the Dark Volume Cap (DVC) Rule on 12∕03∕2018 for the suspension of European securities from dark trading as a natural laboratory to investigate the effect of dark pools on lit market price quality. We empirically demonstrate that the DVC rule has led to an increase of lit price volatility for suspended securities, while it has induced significant lit price inefficiencies for non-suspended securities. Our results suggest that the adverse effects of the DVC rule on lit market price quality are likely to be driven by the migration of a considerable fraction of small and uniformed traders from the dark to the lit market.

Quasi-Dark Trading: The Effects of Banning Dark Pools in a World of Many Alternatives

We show that “quasi-dark” trading venues, i.e., markets with somewhat non-transparent trading mechanisms, are important parts of modern equity market structure alongside lit markets and dark pools. Using the European MiFID II regulation as a quasi-natural experiment, we find that dark pool bans lead to (i) volume spill-overs into quasi-dark trading mechanisms including periodic auctions and order internalization systems; (ii) little volume returning to transparent public markets; and consequently, (iii) a negligible impact on market liquidity and short-term price efficiency. These results show that quasi-dark markets serve as close substitutes for dark pools and consequently mitigate the effectiveness of dark pool regulation. Our findings highlight the need for a broader approach to transparency regulation in modern markets that takes into consideration the many alternative forms of quasi-dark trading.

AuditChain: A Trading Audit Platform Over Blockchain

A blockchain architecture and solution is proposed to audit processing under exchange regulation for trading activity of exchanges. A particular focus is made on dark pools and periodic auctions. An architecture of the solution is described conceptually and an implementation of the proposed solution is made in .NET framework in C# via a RESTful API for chain interaction with the periodic auction venue. The framework proof of concept is tested for different efficiency and latency considerations. This opens the concept to significantly more detailed and extensive developments.

The dark side of liquidity: shedding light on dark pools’ marketing and market-making

ABSTRACT In this article, we explore the case of dark pools of liquidity, which are trading venues that do not display order books and other trading-related data. We argue that, in a context where liquidity remains essentially invisible, dark-pool providers use visual advertisements that iconically represent liquid markets. In so doing, they defuse the idea that dark liquidity is harmful to market efficiency and fair pricing. We use Barthesian and Greimasian semiotics to study how a major bank advertised its dark-liquidity services through iconic visual signs. We contribute to economic sociology and social studies of finance by foregrounding the role of visual advertising in the construction of liquid markets. To do so, we draw on insights from market studies and visual culture.

The Effect of Disclosure Opacity on Trading Opacity: New Evidence from ADR Trades in Dark Pools

As volume increasingly migrates away from exchanges to dark pools, we revisit the link between disclosure opacity and volume, conditional on the choice to trade in a dark venue. We exploit the exogenous variation in home-country reporting opacity to examine how disclosure opacity affects the fraction of ADR volume traded in dark pools. Using multiple metrics for reporting opacity and controlling for firms’ information environment and country-specific governance issues, we find that dark pool volume is positively correlated with home-country reporting opacity. This relation holds after controlling for observable differences between ADRs and other securities that trade in dark pools (matched sample analysis), volume migration to dark pools during earnings announcements, informed trading in lit versus dark venues, ADR levels, IFRS reporting requirements, and the possible endogenous determination of home-country reporting opacity and dark pool volume. The positive relation is stronger for ADRs held by institutions with low turnover and diversified holdings (quasi-indexers), and weaker for ADRs favored by institutions that trade frequently (transient) and institutions that hold concentrated portfolios (dedicated). Bid-ask spreads are greater for higher opacity ADRs that trade in dark pools, indicating that disclosure opacity magnifies the negative effect of dark pool trading on market quality.

Market devices and structural dependency: The origins and development of ‘dark pools’

Abstract‘Dark pools’ are private, electronic share-trading systems in which participants cannot see each other's buy and sell orders. This article shows that the development of these material ‘market devices’ was strongly shaped by the structural dependency of their intended clientele (fund-management firms) on the big investment banks, particularly the indirectly monetary mechanism of dependency known in the US as ‘soft dollars’. The article's underlying argument is that (a) the sociological analysis of financial markets requires bringing together the focus on materiality of, for example, actor-network theory with an emphasis on structural advantage such as that found in field theory; and (b) that both actor-network and field theory approaches could be strengthened by a stronger focus on mundane but important monetary mechanisms such as ‘soft dollars’.

Modelling Intervalling Effect of High Frequency Trading on Portfolio Volatility

This paper theoretically examines whether reducing the minimum trading interval could affect portfolio volatility. Modelling the underlying de-trended asset price with Ornstein Uhlenbeck process, the paper investigates the volatility of portfolios that employ buy and hold strategy and momentum strategy. The paper presents theoretical evidence that the fast trading could increase portfolio price fluctuation and hence potentially suggests another cost of high frequency trading, besides the well-known damages including herding, aggressive trading strategies dark pools, immediate-or-cancel type orders.

Short-term trading skill: An analysis of investor heterogeneity and execution quality

We examine short-horizon return predictability using a novel data set of institutional trades on large-cap U.S. stocks. We estimate investor-specific short-term trading skill and find that there is pronounced heterogeneity in predicting short-term returns among institutional investors. Incorporating short-term predictive ability, our model explains much higher fraction of variation in asset returns. Ignoring the heterogeneity in short-term trading skill can have major implications in modeling price impact. We uncover several stylized trading patterns of skilled trading: skilled investors choose larger trade sizes, avoid dark pools, and trade fewer stocks on any given day, but they do not time high-liquidity periods.

Where Do Hedge Fund Activists Trade?

We analyze how a large informed trader chooses between a lit exchange and a dark pool. We show that (1) the market share of the dark pool increases when the informed trader trades; (2) the market share of the dark pool increases more when the value of information is higher; and (3) price discovery decreases with the value of information. We find empirical support for these predictions using trades from activists reported in Schedule 13D filings. A one-standard-deviation increase in the value of an activist’s information increases the dark pool’s market share by 5.8% and reduces price discovery by 9.7%.

Dark Trading and the Fundamental Information in Stock Prices

Theory suggests that dark pools may facilitate or discourage information acquisition. We find that more dark pool trading leads to greater information acquisition. We measure information acquisition using stock price dynamics around earnings announcements. To overcome endogeneity concerns, we exploit a large exogenous decrease to dark pool trading that results from the implementation of the Security and Exchange Commission’s (SEC’s) Tick Size Pilot Program. The results cannot be explained by lit venue liquidity, algorithmic trading, or informational efficiency. A battery of additional tests, such as documenting a shift in SEC EDGAR searches, supports the information acquisition interpretation.

Dark Pools, Fragmented Markets, and the Quality of Price Discovery

This commentary is on a paper published in 2010. Few would wish to roll the markets back to where they were eight years ago, but have the issues that were debated then been adequately resolved? Are today’s markets acceptably efficient? Can we relax about market quality? My answer to each of these is “no.” What I wrote in 2010, I stand by now. Along with revisiting my previous discussion on dark pools, fragmentation, price discovery, and liquidity, this commentary presents my newer thoughts concerning the definition of the term “liquidity,” and the existence of an illiquidity premium.

COMMENTARY: Dark Pools, Fragmented Markets, and the Quality of Price Discovery: Commentary

This commentary is on a paper published in 2010. Few would wish to roll the markets back to where they were eight years ago, but have the issues that were debated then been adequately resolved? Are today’s markets acceptably efficient? Can we relax about market quality? My answer to each of these is “no.” What I wrote in 2010, I stand by now. Along with revisiting my previous discussion on dark pools, fragmentation, price discovery, and liquidity, this commentary presents my newer thoughts concerning the definition of the term “liquidity,” and the existence of an illiquidity premium.

Shorting in Broad Daylight: Short Sales and Venue Choice

Using a novel database on venue short sales and market design characteristics, we ask: Where do short sellers exploit their information advantage? Consistent with the prediction of Zhu (2014), we find that exchange short sales comprise a larger proportion of trading and are more informative about future prices than dark pool short sales, particularly when there is greater competition among short sellers to trade and in the presence of short-lived information. When examining market design characteristics, we find that dark pools offering volume weighted average price crossing attract more short sales while those offering block trading attract fewer short sales.

The impact of large orders in electronic markets

This paper uses order-level data of all traders of the Italian stock exchange Borsa Italiana (BI) to resolve three issues that remained unsettled in the extant microstructure literature: the interaction between the exchange and a parallel market for large blocks; the asymmetry between the price impacts of buy and sell orders; and the behaviour of liquidity in the limit order book around large orders. Price impacts and liquidity e↵ects of block trades at BI are surprisingly di↵erent from existing empirical literature. Our findings reveal that price e↵ects are much lower in the electronic downstairs market than in the upstairs market. Such result is the opposite of what can be found in previous studies. Moreover, trading costs in the central limit order book at BI are lower than in any other exchange analysed in the past. We explain that in terms of exchange trading architecture. In fact, rules on block trading at BI allowed a parallel dark pool to coexist with the consolidated limit order book well before market liberalization was introduced by the MIFID directive. This left the downstairs market with a selection of liquidity-driven orders and unprecedented low price impacts.