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We show that "quasi-dark" trading venues, i.e., markets with somewhat non-transparent trading mechanisms, are important parts of modern equity market structure alongside lit markets and dark pools. Using the European MiFID II regulation as a quasi-natural experiment, we find that dark pool bans lead to (i) volume spill-overs into quasi-dark trading mechanisms including periodic auctions and order internalization systems; (ii) little volume returning to transparent public markets; and consequently, (iii) a negligible impact on market liquidity and short-term price efficiency. These results show that quasi-dark markets serve as close substitutes for dark pools and consequently mitigate the effectiveness of dark pool regulation. Our findings highlight the need for a broader approach to transparency regulation in modern markets that takes into consideration the many alternative forms of quasi-dark trading.
We study how the informativeness of stock prices changes with the presence of high-frequency trading (HFT). Our estimate is based on the staggered start of HFT participation in a panel of international exchanges. With HFT presence, market prices are a less reliable predictor of future cash flows and investment, even more so for longer horizons. Further, firm-level idiosyncratic volatility decreases, and the holdings and trades by institutional investors deviate less from the market-capitalization weighted portfolio as a benchmark. Our results document that the informativeness of prices decreases subsequent to the start of HFT. These findings are consistent with theoretical models of HFTs' ability to anticipate informed order flow, resulting in decreased incentives to acquire fundamental information.
A tale of one exchange and two order books : effects of fragmentation in the absence of competition
(2018)
Exchanges nowadays routinely operate multiple, almost identically structured limit order markets for the same security. We study the effects of such fragmentation on market performance using a dynamic model where agents trade strategically across two identically-organized limit order books. We show that fragmented markets, in equilibrium, offer higher welfare to intermediaries at the expense of investors with intrinsic trading motives, and lower liquidity than consolidated markets. Consistent with our theory, we document improvements in liquidity and lower profits for liquidity providers when Euronext, in 2009, consolidated its order ow for stocks traded across two country-specific and identically-organized order books into a single order book. Our results suggest that competition in market design, not fragmentation, drives previously documented improvements in market quality when new trading venues emerge; in the absence of such competition, market fragmentation is harmful.