Dark Venues Research Articles

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.

Dark Market Share around Earnings Announcements and Speed of Resolution of Investor Disagreement

ABSTRACTThis study examines how the market share of dark venues changes at earnings announcements. Our analysis shows a statistically significant increase in dark market share in the weeks prior to, during, and following the earnings announcement. We also predict and find evidence that increases in dark market share around earnings announcements are higher for firms with high-quality accounting information. In addition, we find a positive relation between the change in dark market share and the speed of resolution of investor disagreement—a key dimension of informational efficiency, which suggests that dark trading is associated with an improvement in market quality. How market fragmentation changes around news events, the role accounting information plays in market fragmentation, and how changes in market fragmentation relate to market quality can help provide insights to securities regulators.JEL Classifications: G12; G14; D47; M41.

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.

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.

Il teatro en travesti del KTTMCC alias Pumitrozzole

Among the numerous gay performers appearing in off and off-off Italian theatres towards the end of the Seventies one group stood out: the flamboyant and diverse KTTMCC (Kollettivo Teatrale Trousse Merletti Cappuccini e Cappelliere, which could loosely be translated by Theatre Kollective Cosmetic bags, Laces, Cappuccinos and Hat boxes). In its brief but intense life the group performed in theatres, crowded public spaces, and tiny dark venues, always proposing outrageously camp political and social statements. The art of Dada and a taste for camp-ish kitsch seemed to have heavily influenced their “actions” and shows. “The sublime from above and the sublime from below coincide”. They appeared onstage in drag, not the polished and hyper-feminine type of drag popular with the mainstream gay bars clientele, but an ironic, trashy and playful one that came from their texts and from a blend of authentic high-end designer outfits, department stores little dresses, fashionable boots, dangerous platform shoes bought in thrift shops, statement costume jewelry and very, very accurately back-combed wigs. In this text, the author proposes a meeting/interview to three of the original members of the collective, Silvio, Guglielmo and Paolo, now living in different Italian cities, to gather useful information on the KTTMCC’s beginnings and on its decade- long “career” which ended with the controversial TV fame of one of its members, Platinette (boku de cû boku de tet).

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.

Dark Trading and Post-Earnings-Announcement Drift

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 long-standing inefficiency based on under-reaction to quarterly earnings. We study a randomized controlled trial created by the “trade-at” rule of the Securities and Exchange Commission’s Tick Size Pilot Program that exogenously shocks dark trading. We supplement that with ordinary least squares and two-stage least squares regressions on a more representative Compustat/Center for Research in Security Prices sample. All our results suggest that under-reaction increases with dark trading, consistent with reduced liquidity limiting arbitrage. We contribute to the literature on dark trading and inefficient processing of accounting disclosures, highlighting the role of advances in trading technology. This paper was accepted by Brian Bushee, accounting.

Market fragmentation and post-earnings announcement drift

This paper examines the effects of dark and lit market fragmentation around both earnings announcements and earnings surprises. Results indicate that both dark and lit market fragmentation increase around earnings announcements. Further, I test whether dark and lit fragmentation hinder the level of price discovery around the earnings announcement, resulting in greater post-earnings announcement drift, PEAD. The analysis reveals that lit fragmentation has no significant impact on PEAD while dark fragmentation reduces the level of PEAD for stocks with positive earnings surprises. This result is consistent with the notion that dark venues capture more uninformed trading around positive news events, resulting in greater informed trading and higher informational efficiency in the lit venue. However, the results also indicate that dark fragmentation leads to stronger PEAD for stocks with negative earnings surprises. This last finding suggests that informed traders migrate to dark venues around negative earnings surprises, consistent with previous research that argues informed traders follow passive trading strategies around negative news events.

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.

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.

Off-Exchange Trading and Post Earnings Announcement Drift

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.

Dark and Lit Market Fragmentation and Post-Earnings Announcements Drift

This study examines the effects of dark and lit market fragmentation around both earnings announcements and earnings surprises. I find that both dark and lit market fragmentation increase around earnings announcements. I further test whether dark and lit fragmentation hinders the level of price discovery around the earnings announcement, resulting in greater post-earnings announcement drift, PEAD. My analysis reveals that lit fragmentation has no significant impact on PEAD while dark fragmentation reduces the level of PEAD for stocks with positive earnings surprises consistent with the notion that dark venues capture more uninformed trading around positive news events, resulting in greater informed trading and higher informational efficiency on the lit venue. However, my results also indicate that dark fragmentation leads to stronger PEAD for stocks with negative earnings surprises. This last finding suggests that informed traders migrate to dark venues around negative earnings surprise, consistent with previous literature that argues informed traders follow passive trading strategies around negative news events.

An Empirical Analysis of Market Segmentation on U.S. Equity Markets

We examine the impact of trading on markets partially exempt from National Market System requirements (“dark venues”) on equity-market quality. We find evidence consistent with the notion that dark venues rely on their special features to segregate order flow based on asymmetric information risk, which results in their transactions being less informed and contributing less to price discovery on the consolidated market. Except for the execution of large transactions and trading in small stocks, the effects of dark-venue order segmentation are damaging to overall market quality. Our results have important implications for the regulation of international equity markets.

Dark Trading Volume at Earnings Announcements

We examine how abnormal dark market share changes at earnings announcements and find a statistically and economically significant increase in abnormal dark market share in the weeks prior to, during, and following the earnings announcement. The increase in dark market share is larger for firms with a relatively high quality of information environment and a relatively low level of informed trading. These findings are consistent with informed (uninformed) traders facing lower execution (adverse selection) risk in dark venues for firms with a high quality information environment and for firms with low levels of informed trading.

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

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.

Fragmentation and Algorithmic Trading: Joint Impact on Market Quality

We investigate the effects of algorithmic trading and dark venues on U.S. security market quality. Market quality refers to the nearly universal mandate of securities regulators to ensure that all market design changes should not detract from efficiency or fairness which we define as less market manipulation. A simultaneous equations model is used to estimate how fragmentation of the lit and dark order flow interacts with algorithmic trading to determine round-trip transaction costs and end-of-day manipulation. We find that lit market fragmentation lowers effective spreads and reduces manipulation but that fragmentation into the dark raises effective spreads and increases manipulation.

Dark Trading at the Midpoint: Pricing Rules, Order Flow and High Frequency Liquidity Provision

Using over eight trillion observations of market data, we use a regression discontinuity design to analyze the effect of increasing the minimum price variation (MPV) for quoting equity securities in light of recent proposals to increase the MPV from $0.01 to $0.05. We show that a larger MPV encourages investors to trade in dark venues at the midpoint of the national best bid and offer. Enhanced order flow to dark venues reduces price competition by exchange liquidity providers, especially those using high frequency trading (HFT). Trading in dark venues due to a wider MPV reduces volatility and increases trading volume.

Ranking the Performance of U.S. Dark Venues

Dark venues have become a significant part of the U.S. equity market. More than 50 dark venues exist currently, with a market share of approximately 18% to 22%. Given this presence in the marketplace, institutional traders are perhaps missing a significant portion of the market if they avoid dipping their toes into the world of dark liquidity. Yet with the large number of dark venues that exist, it is extremely difficult to ascertain the amount of natural liquidity present in each venue, as well as the execution quality that each venue provides back to the parent order. Can every dark venue be adding value back to the end investor? <b>TOPICS:</b>Exchanges/markets/clearinghouses, equity portfolio management

An Empirical Analysis of Market Segmentation on U.S. Equities Markets

We examine the impact of trading on markets partially exempt from National Market System requirements (‘dark venues’) on equity market quality. We find evidence consistent with the notion that dark venues rely on their special features to segregate order flow based on asymmetric information risk, which results in their transactions being less informed and contributing less to price discovery on the consolidated market. Except for the execution of large transactions and trading in small stocks, the effects of dark venue order segmentation are damaging to overall market quality. Our results have important implications for the regulation of international equity markets.

Informational Linkages Between Dark and Lit Trading Venues

We examine the linkages between dark and lit venues using a proprietary data set. We find that algorithmic trades for less liquid stocks lead to higher spreads and price impact, and correlated trading on the lit venues. Also, signed trades for these stocks predict future returns over the next 15 to 120 minutes. Trades for liquid stocks, trades by the dark venue brokerage desk, and members trading large blocks in negotiated crosses transmit less information to the lit venues. The results suggest that dark venues allow informed agents to trade strategically on both venues and facilitate the price discovery process.