We investigate the welfare implications of operating alternative market structures known as electronic crossing networks or "dark pools" alongside traditional "lit" markets. We study equilibria of a market where intrinsic traders and speculators, endowed with heterogeneous fine-grained information, endogenously choose between dark and lit venues. We establish that while the dark pool attracts relatively uninformed investors, the orders therein experience adverse selection. Moreover, the informational segmentation created by a dark pool leads to greater transaction costs in the lit market. Taken together, we conclude that there exist reasonable parameter regimes where introducing a dark pool decreases the overall welfare.

Kris Iyer, Ramesh Johari, and Ciamac Moallemi
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Iyer, Kris, Ramesh Johari, and Ciamac Moallemi
. Welfare analysis of dark pools. September 10, 2015.