An Empirical Analysis of Market Segmentation on U.S. Equities Markets

This paper examines the impact of trading on markets partially exempt from National Market System requirements on equity market quality. Lit and dark trading venues differ in their regulatory structure most notably in whether they must provide fair-access and pre-trade transparency and restrict sub-penny trading increments. We find evidence consistent with the notion that dark venues rely on their special features to segregate order flow based on asymmetric information risk, which results in their transactions being less informed and contributing less to price discovery on the consolidated market. We show that the effects of order segmentation by dark venues are damaging to overall market quality except for the execution of large transactions