Dark trading and alternative execution priority rules

Traders' choice between lit and dark trading venues depends on market conditions, which are affected by execution priority rules in the dark pool, adverse selection, and traders' competition. We show that dark trading activity has a non-linear relationship with asset volatility and liquidity, which explains previous mixed empirical results regarding the impact of dark pools on market quality. The introduction of dark pools increases welfare only for speculators, while other traders (even large traders) are worse off. Importantly, we show that a size execution priority rule improves global welfare and liquidity relative to a time execution priority for dark orders.