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

Abstract

We exploit a unique natural experiment—recent restrictions of dark trading in Canada—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, dark midpoint crossing systems do not benefit 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. JEL classification: G1