Univ. of North Carolina | June 17, 2015
Theory suggests that the impact of dark pools on market quality and efficiency will depend in part on the degree of informed trading they host.
Using a novel collection of off-exchange trade and corporate news release data, the author studies where short sellers exploit their well-documented information advantage.
Unconditionally, he finds stronger evidence of return predictability for short sales executed on exchanges compared to short sales executed in dark pools. In periods surrounding news releases, dark pools host an increased proportion of total trading volume; however, he finds weaker evidence of abnormal dark pool short sales anticipating value-relevant news releases compared to such trading on exchanges.
In this paper, the author focus on trading which is an outcome of the order routing process. In the sample, he finds that short sales executed on exchanges comprise 51.43% of exchange trading volume while short sales executed in dark pools comprise 45.31% of dark pool trading volume. Unconditionally, he finds that stocks which are heavily shorted in dark pools and on exchanges underperform corresponding lightly shorted stocks by a four factor adjusted value-weighted average of 0.56% and 1.02% over the following 20 trading days (6.74% and 12.19% annualized), respectively.
As for trading around news releases, the results are more nuanced. Dark pools host both increased trading volume and an increased proportion of total trading volume surrounding news events. While he observes increased volume and short sale volume in dark pools prior to news releases, which may provide more opportunities for the informed to trade, he finds relatively weak evidence of abnormal short selling in dark pools prior to news releases vis-`a-vis such trading on exchanges.
When the author separates news releases into scheduled and unscheduled events, he finds that dark pools primarily capture an increased proportion of trading when arrival of news is scheduled. Furthermore, he finds evidence of abnormal exchange short selling prior to unscheduled negative news and evidence of increased 20 day return predictability of exchange short sellers on the day prior to unscheduled news releases, but no such result for dark pool abnormal short sales or the return predictiability of dark pool short sales on those days. I do not find evidence of increased 20 day return predictability of short sellers in dark pools or on exchanges on news release days.
The balance of this paper proceeds as follows: Section I reviews the relevant literature, Section II discusses the novel collection of data employed in this study, Section III presents the methodology and results, Section IV provides a discussion, and Section V concludes.
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