OPTIMAL LIQUIDATION AND ADVERSE SELECTION IN DARK POOLS

Source abstract

Abstract We consider an investor who has access both to a traditional venue and a dark pool for liquidating a position in a single asset. While trade execution is certain on the traditional exchange, she faces linear price impact costs. On the other hand, dark pool orders suffer from adverse selection and trade execution is uncertain. Adverse selection decreases order sizes in the dark pool while it speeds up trading at the exchange. For small orders, it is optimal to avoid the dark pool completely. Adverse selection can prevent profitable round‐trip trading strategies that otherwise would arise if permanent price impact were included in the model.