City goes dark: Dark trading and adverse selection in aggregate markets |
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| Institution: | 1. Lazaridis School of Business and Economics, Wilfrid Laurier University, 75 University Avenue, Waterloo, Ontario, N2L 3C5, Canada;2. DeGroote School of Business, McMaster University, 1280 Main Street West, Hamilton, Ontario, L8S 4M4, Canada |
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| Abstract: | We investigate the impact of dark trading on adverse selection in an aggregate market for trading UK stocks. Dark trading is linked to lower adverse selection risk and improved informational efficiency and liquidity in the aggregate market, even as liquidity declines in the lit market with dark trading. However, there is a trading value-based threshold when dark trading starts to induce adverse selection. We estimate that this threshold varies from around 9% for the most liquid stocks to 25% for the least liquid stocks. The overall average threshold for the 288 FTSE 350 stocks in our sample is 14%. |
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| Keywords: | Dark pools Adverse selection Market liquidity Pricing noise Informational efficiency |
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