Shades of Darkness: A Pecking Order of Trading Venues

Abstract

Investors trade in various types of venues. When demanding immediacy they face a basic tradeoff between price impact and execution uncertainty. Venues can be sorted accordingly along a "pecking order," with mid-point dark pools and lit markets at the top and bottom, and non-midpoint pools in the middle. A simple model formalizes this pecking order hypothesis. We test it using a unique dataset that disaggregates U.S. dark trading into various categories. A higher VIX or larger earnings surprise tilts trading volumes from the top of the pecking order to the bottom, confirming the hypothesis.

Two Shades of Opacity: Hidden Orders versus Dark Trading

“…Although not explicitly modeled, the impact of exposure is implicit in the greater market impact of visible orders on lit venues. A similar reasoning is followed by Menkveld, Yueshen, and Zhu (2014) The reduced exposure costs for dark venue orders make them similar in nature to hidden orders. For both opaque order types reduced exposure also comes at the cost of lower execution probabilities.…”

“…Menkveld, Yueshen, and Zhu (2014) show that the degree to which traders desire immediacy is an important determinant of venue selection. They argue that dark and lit trading venues can be ranked according to a pecking order.…”

Shorting in Broad Daylight: Short Sales and Venue Choice

“…Following Comerton-Forde et al 2016, we also examine the intraday informativeness of venue short sales. Biais, Hillion, and Spatt (1995) and Menkveld et al (2017) show that trading volume is persistent and that trading can be correlated across venues. To allow for these possibilities, we follow Comerton-Forde et al (2016) by adapting the Hasbrouck (1991) information-contentof-trade framework to our partition of short sales.…”

“…Although our paper's focus is short selling, another paper by Menkveld, Yueshen, and Zhu (2017) examining venue choice was developed contemporaneously. We examine the specifics of short selling, studying a distinct set of predictions regarding venue choice under asymmetric information by using signed trading volume.…”

Order-Flow Segmentation, Liquidity, and Price Discovery: The Role of Latency Delays

“…Our work contributes to the broad literature on market segmentation, which includes (but is not limited to) studies on dark pools (e.g., Zhu (2014), Menkveld, Yueshen, and Zhu (2017)), access fees (e.g., Colliard and Foucault (2012), Malinova and Park (2015)), and broker order-routing decisions (e.g., Battalio, Corwin, and Jennings (2016), Cimon (2019)). Empirical work shows that fragmented markets improve liquidity (Foucault and Menkveld (2008)) and efficiency (O'Hara and Ye (2011)).…”