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Should we be afraid of the dark? Dark trading and market quality

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  • Foley, Sean
  • Putniņš, Tālis J.

Abstract

We exploit a unique natural experiment—recent restrictions of dark trading in Canada and Australia—and proprietary trade-level data to analyze the effects of dark trading. Disaggregating two types of dark trading, we find that dark limit order markets are beneficial to market quality, reducing quoted, effective, and realized spreads and increasing informational efficiency. In contrast, we do not find consistent evidence that dark midpoint crossing systems significantly affect market quality. Our results support recent theory that dark limit order markets encourage aggressive competition in liquidity provision. We discuss implications for the regulation of dark trading and tick sizes.

Suggested Citation

  • Foley, Sean & Putniņš, Tālis J., 2016. "Should we be afraid of the dark? Dark trading and market quality," Journal of Financial Economics, Elsevier, vol. 122(3), pages 456-481.
  • Handle: RePEc:eee:jfinec:v:122:y:2016:i:3:p:456-481
    DOI: 10.1016/j.jfineco.2016.08.004
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Markus Baldauf & Joshua Mollner, 2015. "Trading in Fragmented Markets," Discussion Papers 15-018, Stanford Institute for Economic Policy Research.
    2. Menkveld, Albert J. & Yueshen, Bart Zhou & Zhu, Haoxiang, 2017. "Shades of darkness: A pecking order of trading venues," Journal of Financial Economics, Elsevier, vol. 124(3), pages 503-534.
    3. Carole Gresse, 2017. "Effects of Lit and Dark Market Fragmentation on Liquidity," Post-Print hal-01631771, HAL.
    4. repec:wly:jfutmk:v:37:y:2017:i:4:p:411-428 is not listed on IDEAS
    5. repec:cup:jfinqa:v:52:y:2017:i:06:p:2399-2427_00 is not listed on IDEAS
    6. Carole Gresse, 2011. "Effects of Lit and Dark Market Fragmentation on Liquidity," Post-Print halshs-00641122, HAL.
    7. repec:eee:pacfin:v:43:y:2017:i:c:p:188-199 is not listed on IDEAS
    8. Aitken, Michael & Chen, Haoming & Foley, Sean, 2017. "The impact of fragmentation, exchange fees and liquidity provision on market quality," Journal of Empirical Finance, Elsevier, vol. 41(C), pages 140-160.
    9. Kwan, Amy & Masulis, Ronald & McInish, Thomas H., 2015. "Trading rules, competition for order flow and market fragmentation," Journal of Financial Economics, Elsevier, vol. 115(2), pages 330-348.
    10. Vinay Patel, 2015. "Price Discovery in US and Australian Stock and Options Markets," PhD Thesis, Finance Discipline Group, UTS Business School, University of Technology, Sydney, number 27, january-d.
    11. Corey Garriott & Anna Pomeranets & Joshua Slive & Thomas Thorn, 2013. "Fragmentation in Canadian Equity Markets," Bank of Canada Review, Bank of Canada, vol. 2013(Autumn), pages 20-29.
    12. Meling, Tom Grimstvedt & Odegaard, Bernt Arne, 2016. "Tick Size Wars," UiS Working Papers in Economics and Finance 2016/15, University of Stavanger.

    More about this item

    Keywords

    Dark pool; Dark trading; Regulation; Liquidity; Market efficiency; Transparency;

    JEL classification:

    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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