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Dynamic Dark Pool Trading Strategies in Limit Order Markets

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  • Sabrina Buti
  • Barbara Rindi
  • Ingrid M. Werner

Abstract

We model a dynamic financial market where traders submit orders either to a limit order book (LOB) or to a Dark Pool (DP). We show that there is a positive liquidity externality in the DP, that orders migrate from the LOB to the DP, but that overall trading volume increases when a DP is introduced. We also demonstrate that DP market share is higher when LOB depth is high, when LOB spread is narrow, when the tick size is large and when traders seek protection from price impact. Further, while inside quoted depth in the LOB always decreases when a DP is introduced, quoted spreads can narrow for liquid stocks and widen for illiquid ones. We also show that traders' interaction with both LOB and DP generates interesting systematic patterns in order ?ow: di¤erently from Parlour (1998), the probability of a continuation is greater than that of a reversal only for liquid stocks. In addition, when depth decreases on one side of LOB, liquidity is drained from DP. When a DP is added to a LOB, total welfare as well as institutional traders' welfare increase but only for liquid stocks; retail traders' welfare instead always decreases. Finally, when flash orders provide select traders with information about the state of the DP, we show that more orders migrate from the LOB to the DP, and DP welfare effects are enhanced.

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Paper provided by IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University in its series Working Papers with number 371.

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Date of creation: 2010
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Handle: RePEc:igi:igierp:371

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  1. Moinas, Sophie, 2010. "Hidden Limit Orders and Liquidity in Order Driven Markets," IDEI Working Papers, Institut d'Économie Industrielle (IDEI), Toulouse 600, Institut d'Économie Industrielle (IDEI), Toulouse.
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Cited by:
  1. Degryse, H.A. & Jong, F.C.J.M. de & Kervel, V.L. van, 2011. "The Impact of Dark and Visible Fragmentation on Market Quality (Replaces CentER Discussion Paper 2011-051)," Discussion Paper, Tilburg University, Center for Economic Research 2011-069, Tilburg University, Center for Economic Research.

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