Volatility, dark trading and market quality: evidence from the 2020 COVID-19 pandemic-driven market volatility

We exploit the exogenous shock of the COVID-19 pandemic on financial markets and regulatory restrictions on dark trading to investigate how volatility drives dark market share and trader venue selection. We find that, consistent with theory, excessive volatility on lit exchanges is linked with an economically significant loss of market share by dark pools to lit exchanges. The dynamics of market share loss are driven by the cross-migration of informed and uninformed traders between lit and dark venues. Informed traders migrate from lit venues to dark venues when lit venues’ volatility becomes excessive, while uninformed traders, wary of the presence of informed traders in dark pools, shift their trading to lit exchanges rather than delay trading in a volatile market environment. The market quality implications of the cross-migration are mixed: while it improves liquidity on the lit exchange, it results in a loss of informational efficiency.

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