Size Discovery∗

Abstract

Size discovery refers to the use of trade mechanisms by which large quantities of an asset can be exchanged at a price that does not respond to price pressure. Primary examples of size discovery include “workup, ” a trade protocol used in the markets for U.S. Treasuries and swaps, and block-trading “dark pools, ” used in equity markets. By freezing the execution price, a size-discovery mechanism does not clear the market, but overcomes large investors ’ concerns over their price impacts. Price-discovery mechanisms, which determine a market-clearing price by matching supply and demand, cause investors to internalize their price impacts, inducing costly delays in the reduction of position imbalances. We show that augmenting a price-discovery mechanism with a size-discovery mechanism such as workup or dark pools improves allocative efficiency. Because of adverse selection regarding the order imbalances of other investors, size discovery is used only by investors with large position imbalances