Dark Pools Research Articles

The relevance of dark trading for information acquisition in the German stock market

The implementation of the European double volume cap (DVC) mechanism acts as an exogenous shock to help understand how restrictions on dark trading affect the price discovery process for German stocks. Using the price jump ratio as a measure of information acquisition prior to earnings announcements, we show that dark pool trading aids information acquisition. This relationship is stronger for negative earnings news, for stocks that are hard to value, and when there is uncertainty around earnings. The introduction of the DVC mechanism weakens the relationship between dark trading and pre-announcement information acquisition.

A law and economic analysis of trading through dark pools

A law and economic analysis of trading through dark pools

Convexity in Real-time Bidding and Related Problems

We study problems arising in real-time auction markets, common in e-commerce and computational advertising, where bidders face the problem of calculating optimal bids. We focus upon a contract management problem where a demand aggregator is subject to multiple contractual obligations requiring them to acquire items of heterogeneous types at a specified rate and where they will seek to fulfill these obligations at minimum cost. Our main results show that, through a transformation of variables, this problem can be formulated as a convex optimization problem, for both first and second price auctions. The resulting duality theory admits rich structure and interpretations. Additionally, we show that the transformation of variables can be used to guarantee the convexity of optimal bidding problems studied by other authors, who did not leverage convexity in their analysis. The main point of our work is to emphasize that the natural convexity properties arising in first and second price auctions are not being fully exploited. Finally, we show direct analogies to problems in financial markets: the expected cost of bidding in second price auctions is formally identical to certain transaction costs when submitting market orders, and that a related conjugate function arises in dark pool financial markets.

Execution uncertainty of dark pools and portfolio balance

Execution uncertainty can disrupt portfolio balance; for example, dark pool orders for some assets in the portfolio are executed while others are not. To alleviate this problem, we consider a conditional dark pool order in a discrete model of the optimal portfolio execution strategy. Conditional dark pool orders allow an investor to submit a portfolio that will be executed only if the condition that all assets in the portfolio are executable is met. Additionally, dark pools are trading systems established for large transactions. We provide new insight into the puzzle of small average dark pool order size through portfolio balance.

Understanding the impacts of dark pools on price discovery

I study how crossing networks, a type of dark pool, affect price discovery and market liquidity in the presence of noisy and heterogeneous trader signals. I identify a buffer function of crossing networks that helps mitigate traders’ losses from false signals. Additionally, I uncover an amplification effect. That is, when signal precision is high, crossing networks enhance price discovery. By contrast, when signal precision is low, crossing networks impair price discovery. These insights reconcile conflicting empirical evidence, yielding novel predictions and regulatory recommendations for equity and emerging markets.

Welfare and Gains from Trade in Dark Pools

Welfare and Gains from Trade in Dark Pools

Sharks in the dark: Quantifying HFT dark pool latency arbitrage

We investigate stale reference pricing and liquidity provision in dark pools using proprietary, participant-level regulatory data. We show a substantial amount of stale trading occurs, imposing large costs on passive dark pool participants. Consistent with these costs, HFTs almost never provide liquidity in the dark, instead frequently consuming liquidity, in particular in order to take advantage of stale reference prices. Finally, we show that market design interventions randomizing dark execution times are successful at countering dark pool latency arbitrage, protecting passive providers of dark liquidity. Our results have substantial implications for practitioners and policymakers aiming to improve liquidity provision in dark pools.

Tick size, liquid stocks and market quality: Evidence from a natural experiment in a unique setting

We study the causal impacts of a tick size reduction policy in highly liquid stocks, exploiting a unique experiment in Borsa Istanbul leading to substantial exogenous variation in the tick size. Adapting a differences-in-differences strategy with a novel limit order and trade book data with intraday calculations, we find evidence that the tick size reduction improves market quality for the liquid stocks by significantly lowering quoted, effective, and realized spread yet reducing the depth at the best bid offer and aggregate depth. Moreover, results indicate a lower price impact for the treated stocks while there is no significant impact on trading volume, however, the number of trades increases but trade and order sizes get smaller significantly. Estimates show null effects on the submission of market orders, volatility, and returns. Our study departs from the existing literature with no dark pool trading and internalization of orders in the Turkish Stock Markets.

Information and optimal trading strategies with dark pools

This paper examines the effects of the competition between asset trading venues with different levels of transparency: an opaque dark pool alongside a transparent exchange organized as a limit order book (two-venue market). In a model with asymmetric information, we compare traders’ strategies and market performance in the two-venue market with that of a single-venue market (trading only in the exchange). We show that price informativeness is lower in the two-venue market when informed traders migrate to the dark pool and uninformed investors remain in the exchange. We also find that when orders migrate to the dark pool in the first period, market liquidity is lower (higher) in the two-venue market for high (low) fundamental volatility stocks as traders migrating to the dark pool would have demanded (supplied) liquidity in the exchange. Finally, the expected profits of informed traders are never lower in the two-venue market, but this may not always be true for uninformed traders.

An Efficient Data-Independent Priority Queue and its Application to Dark Pools

We introduce a secure data-independent priority queue which supports polylogarithmic-time insertion operations and constant-time deletions and read-front (aka peek) operations as opposed to the originally introduced queue by Toft (PODC '11). Moreover, we minimize the number of comparisons required to perform different operations on Toft's priority queue. Data-independent data structures—first identified explicitly by Toft, and further elaborated by Mitchell and Zimmerman (STACS '14)—serve the purpose of computing on encrypted data without executing branching code which can be used to avoid prohibitively expensive operations in secure computation applications. Focusing on the costly sorting operations, we show significant asymptotic improvements over prior privacy preserving dark pool applications. Dark pools are securities-trading venues which attain ad-hoc order privacy, by matching orders outside of publicly visible exchanges via the so-called dark pool operators. In this paper, we describe an efficient and secure dark pool (implementing a full continuous double auction) based on our new priority queue. Our construction's security guarantees are cryptographic based on secure multiparty computation (MPC), and do not require that the dark pool operators are trusted. Our construction improves upon the asymptotic efficiency attained by previous efforts. Existing cryptographic dark pools process new orders in time which grows linearly in the size of the standing order book; ours does so in polylogarithmic time. We describe a concrete implementation of our MPC protocol with malicious security in the honest majority setting. We also report benchmarks of our implementation and compare them to prior works. Our protocol reduces the total running time by several orders of magnitude over prior secure dark pool solutions.

Banning dark pools: Venue selection and investor trading costs

We analyze the relation between transaction costs and venue choice using proprietary transaction-level data from institutional trade executions in the U.K. equity market. We show that, for a given investor, a higher share of dark trading (midpoint dark pools) is associated with lower execution costs. In the context of a recent ban on dark trading, we provide evidence consistent with migration towards substitute trading venues such as periodic auctions, which has mitigated adverse effects on trading costs for large investors. We also provide micro-evidence on Menkveld et al.’s (2017) pecking order theory of venue choice over the life-cycle of large parent orders.

Spoilt for choice: Determinants of market shares in fragmented equity markets

We analyze the determinants of the trading volumes of different trading mechanisms in equity markets using an extensive panel data set from European markets comprising public limit order books, call auctions, dark pools, internalization platforms, and the over-the-counter market. Market shares, resulting from investors’ order routing decisions, are driven by the degree of immediacy and anonymity offered by the venues, their ability to offer off-tick executions, as well as the informational environment and conditions in the market. Findings for small and large trades are distinctly different, likely because traders jointly choose trade size and venue type.

Volatility and dark trading: Evidence from the Covid-19 pandemic

We study the effect(s) of volatility on the share of trading in dark pools by exploiting the exogenous shock of the Covid-19 pandemic on financial markets and regulatory restrictions on dark trading. We find that high levels of volatility in lit exchanges is linked to an economically significant loss of market share by dark pools to lit exchanges. In line with the theory, the loss appears to be driven by informed traders’ migration from lit to dark markets during high volatility periods. The market quality implications of the trading dynamics are mixed: while it tempers liquidity decline in the lit market, it exacerbates the loss of informational efficiency.

Market Making and Incentives Design in the Presence of a Dark Pool: A Stackelberg Actor–Critic Approach

A Stackelberg actor–critic approach to optimal market making and incentives design with dark pools. We consider the issue of a market maker acting at the same time in the lit and dark pools of an exchange. The exchange wishes to establish a suitable make–take fee policy to attract transactions on its venues. We first solve the stochastic control problem of the market maker without the intervention of the exchange. Then, we derive the equations defining the optimal contract to be set between the market maker and the exchange. This contract depends on the trading flows generated by the market maker’s activity on the two venues. In both cases, we show existence and uniqueness, in the viscosity sense, of the solutions of the Hamilton–Jacobi–Bellman equations associated to the market maker and exchange’s problems. We finally design an actor–critic algorithm inspired by deep reinforcement learning methods, enabling us to approximate efficiently the optimal controls of the market maker and the optimal incentives to be provided by the exchange.

The Effect of Reporting Opacity on Trading Opacity: New Evidence from American Depositary Receipt Trades in Dark Pools*

ABSTRACTTrading volume is increasingly shifting to dark venues, and the causes of this move are not well understood. We examine whether a firm's reporting opacity affects its dark pool trading and provide robust evidence that (partly) explains this volume migration. Exploiting the exogenous variation in home‐country reporting opacity in a sample of American Depositary Receipts (ADRs) and using multiple metrics for reporting opacity, we find that greater opacity associates with increased dark pool trading. This relation holds after controlling for firms' information environments, country‐specific governance issues, 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 (quasi‐indexing) institutions with low turnover and diversified holdings and weaker for ADRs favored by (transient) institutions that trade frequently and (dedicated) institutions that hold concentrated portfolios. Bid‐ask spreads are greater for higher opacity ADRs that trade in dark pools, indicating that reporting opacity is associated with the negative effect of dark pool trading on market quality. Our findings help inform the current debate on off‐exchange trading by showing how reporting regimes affect the trading venue choice.

Does the bid–ask spread affect trading in exchange operated dark pools? Evidence from a natural experiment

We exploit exogenous reductions in the minimum tick size to examine the effect of the bid–ask spread in the lit market on dark trading activity in the exchange operated dark pool in Japan. Stocks affected by the minimum tick size experience a decline in the share of trading in the exchange operated dark pool. The decrease in the share of dark trading is mostly evident among stocks with a constrained tick size prior to the tick size changes. Overall, our findings imply that reducing the minimum tick size can help lit venues regain market shares over dark venues.

Hidden liquidity, market quality, and order submission strategies

Using exogenous changes in hidden liquidity from the Tick Size Pilot Program, we show that hidden liquidity on lit venues has significant effects on various measures of market quality and order submission strategies after controlling for the impact of dark pools and stock attributes. We find that spreads, depths, trading volume, and trade size increase with hidden liquidity. The extent of informed trading and the price impact of a trade also increase with hidden liquidity on lit venues. Traders use more inside-the-quote limit orders, while algorithmic traders engage in more pinging activities and raise message traffic with more hidden liquidity.

Diving into dark pools

AbstractWe study 2009 and 2020 dark trading for U.S. stocks. Dark trading is lower when volume is low, volatility high, and in periods of markets stress. Dark pools are more active for large caps, while internalization is more common for small caps. Traders use dark pools to jump the queue for large caps in 2009, and to avoid crossing the spread for small caps in both years. Internalization is higher when spreads are wide and depth is high. Dark pool trading improves spreads in 2009, but worsens market quality for large caps in 2020. We discuss explanations for the change.

Informed Trading in Dark Pools: Fair-Access Dark Venue vs. Restricted-Access Dark Venues

Prior empirical studies find that dark pools are, on average, associated with uninformed order flow. The “exemption from fair-access requirement” has been conjectured as a necessary condition for dark venues to segment uninformed order flow. This study presents direct evidence contrasting a dark venue that offers equal access to all market participants to other dark pools which have the ability to subjectively exclude order flow. Using the period leading up to surprise corporate earnings news, I document robust evidence of informed trading taking place in the fair access dark venue. I do not find such evidence in other dark venues.

Simplified image acquisition and detection of ischemic and non-ischemic myocardial fibrosis with fixed short inversion time magnetic resonance late gadolinium enhancement.

Late gadolinium enhancement with fixed short inversion time (LGEshort) provides excellent tissue contrast with dark scar and bright blood pool and does not need prior myocardial nulling. We hypothesize better visibility of ischemic scars and equal visibility of non-ischemic LGE in LGEshort compared to clinically established LGE (LGEstandard). LGEshort and LGEstandard were retrospectively evaluated in 179 patients (3043 segments) with suspected or known coronary artery disease by four blinded readers (reader A: most experienced - D: least experienced). The amount of ischemic and non-ischemic LGE as well as visibility (4: very good - 1: poor) of ischemic LGE was visually assessed. All readers detected more infarcted segments in LGEshort compared to LGEstandard (378 segments reported as infarcted; A:p = 0.5, B:p = 0.8, C,D:p = 0.03). Scar visibility was scored higher in LGEshort by all readers (A,B:p = 0.03; C,D:p = 0.02), especially for subendocardial infarcts (A,B:p = 0.04, C,D:p = 0.02). Less experienced readers detected significantly more infarcted papillary muscles (C:p = 0.02, D:p = 0.03) in a shorter reading time in LGEshort (C:p = 0.04, D:p = 0.02). Non-ischemic LGE was equally visible in both sequences (A:p = 0.9, B:p = 0.8, C,D:p = 0.6). LGEshort detects more ischemic LGE with improved scar visibility compared to LGEstandard, independent of experience level. The visibility of non-ischemic LGE is equivalent to LGEstandard. Less experienced readers can diagnose ischemic and non-ischemic LGE faster in LGEshort. LGEshort with its maximal operational simplicity can be used for visualization of all types of fibrosis - ischemic and non-ischemic - instead of LGEstandard, independent of experience level.