Reference

Ariadna Dumitrescu (ESADE Business School), Information and Optimal Trading Strategies with Dark Pools, Fédération des Banques Françaises Seminar, TSE, November 6, 2017, 12:30–14:00, room MF 323.

Abstract

We study how asymmetric information affects market participants’ choice of trading venue (either an exchange or dark pool), and the optimal submission strategies in a sequential trading game. The exchange is organized as a fully transparent limit order book, and the dark pool is an opaque venue where orders are continuously executed at the midpoint of the bid and ask prices that prevail in the exchange. We find that, when the limit order book conveys no information, rational uninformed traders never trade in the dark pool due to price risk. However, price risk may be reduced when the information in the book induces an uninformed buyer (seller) to believe that the value of the asset is high (low) since the order was previously submitted by an informed buyer (seller). Adding a dark pool alongside an exchange may divert the informed trader from the exchange to the dark pool if the execution risk in the dark is sufficiently low. An uninformed trader only goes to the dark if the limit order book is sufficiently informative and price risk is low. We show that adding a dark pool alongside an exchange reduces price informativeness and increases the expected welfare of rational traders. Its effects on market liquidity and trading volume depend on stock market characteristics since these determine whether traders supply, demand or do not provide liquidity in the exchange when the dark pool is unavailable.

Research partnership

Fédération des Banques Françaises Research Initiative (sustainable)