[11:04 19/2/2014 RFS-hht078.tex] Page: 747 747–789 Do Dark Pools Harm Price Discovery?

Dark pools are equity trading systems that do not publicly display orders. Dark pools offer potential price improvements but do not guarantee execution. Informed traders tend to trade in the same direction, crowd on the heavy side of the market, and face a higher execution risk in the dark pool, relative to uninformed traders. Consequently, exchanges are more attractive to informed traders, and dark pools are more attractive to uninformed traders. Under certain conditions, adding a dark pool alongside an exchange concentrates price-relevant information into the exchange and improves price discovery. Improved price discovery coincides with reduced exchange liquidity. (JEL G12, G14, G18) Dark pools are equity trading systems that do not publicly display orders. Some dark pools passively match buyers and sellers at exchange prices, such as the midpoint of the exchange bid and offer. Other dark pools execute orders by their price and time priority. According to the Securities and Exchange Commission (SEC 2010), as of September 2009, thirty-two dark pools in the United States accounted for 7.9 % of total equity trading volume. As of mid-2011, industry estimates from the Tabb Group, a consultancy, and Rosenblatt Securities,