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

Article Source: Capital Markets CRC limited


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.

Keywords: Market Fragmentation; Security Market Regulation; Market Efficiency

We thank Tarun Chordia, Robert Faff, Douglas Foster, Tom Smith, Peter Swan, Terry Walter, and seminar participants at Australian National University, Florida International University, The University of New South Wales,
The University of Technology, Sydney, Australian Securities and Investments Commission and U.S. Securities and Exchange Commission for helpful comments. We thank NASDAQ OMX for providing the data for this research. The data employed in this research are equivalent to the TAQ data publicly available through databases such as WRDS. The views expressed herein are not intended to represent the views of NASDAQ OMX, its employees, or directors. The authors are solely responsible for the content, which is provided for informational and educational purposes only. Nothing contained herein should be construed as investment advice, either on behalf of a particular security or an overall investment strategy.

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