Dark Trading at the Midpoint: Does SEC Enforcement Policy Encourage Direct Feed Arbitrage?

Robert P. Bartlett and Justin McCrary

Journal of Law, Finance, and Accounting, 2019, vol. 4, issue 2, 291-342

Abstract: Prevailing research in market microstructure posits that liquidity providers bypass queue lines on exchanges by offering liquidity in dark venues with de minimis sub-penny price improvement, thus exploiting an exception to the penny quote rule. We show that (a) the SEC enforces the quote rule to prevent sub-penny queuejumping in dark pools unless trades are “pegged†to the NBBO midpoint and (b) the documented increase in dark trading due to investor queue-jumping stems from increased midpoint trading. Although encouraging pegged midpoint orders can subject traders to direct feed arbitrage, we estimate that less than 2% of shares traded per year present exploitable trading opportunities for this form of latency arbitrage, yielding annual gross potential profits of less than $20 million.

Keywords: Latency arbitrage; high-frequency trading; dark pools; tick sizes; market structure (search for similar items in EconPapers)
JEL-codes: G10 G15 G18 G23 G28 K22 (search for similar items in EconPapers)
Date: 2019
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Persistent link: https://EconPapers.repec.org/RePEc:now:jnllfa:108.00000039

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