Albert J. Menkveld

My two cents

Shades of Darkness. A Pecking Order of Trading Venues

Suppose you gave your girlfriend her favorite concert on her birthday. The cry of joy and the smile across her face. Irresistible.

But, you don’t have the ticket yet. You just created yourself a short position of a ticket, or two tickets really. No problem, plenty of time to find them.

SOLD OUT. No worries, there is always EBay. Indeed plenty of intermediaries with tickets but, wow, that price is outrageous! You decide to post your interest in your favorite local “Craigslist.” People like you might have purchased tickets in the past and discovered they couldn’t go. They must be in for a reasonable deal.

You have just put your trade interest in a “dark pool,” foregoing the option of immediacy available in a regular exchange, the “lit market.” Cheaper, but uncertain.

In a new paper with Bart Zhou Yueshen (INSEAD) and Haoxiang Zhu (MIT), we explore whether this fundamental trade-off can generate a “pecking order” of trade venues. We benefit from a unique dataset on U.S. equity trades through three types of venues: dark pools that cross at the midpoint (DarkMid), dark pools that cross at a price other than the midpoint (DarkNMid), and regular exchanges (Lit).

We hypothesize that these venues can be ranked as follows:


The paper develops two main results. First, this “pecking order” of venues can be established theoretically in the following sense. A simple model shows that strategic traders use all three venues in equilibrium and tilt their flow towards lit markets when they become impatient.

Second, empirical analysis supports this notion of a pecking order. Equity trade migrates towards the lit market when investors are hit with an urgency shock. The latter is proxied for by an exogenous shock to VIX, or “macro volatility.” We assume that it becomes costly to wait in such environment. The following impulse response functions (to a shock in VIX) are perhaps the paper’s key result.


My personal VIX shock was when my girlfriend asked me to remind her of the exact date of the concert. A soft sweat broke on my forehead. I rushed to Lit and purchased the tickets … grudgingly.

You find the paper here.