Understanding the Impacts of Dark Pools on Price Discovery

We investigate the impact of dark pools on price discovery and liquidity when traders' signals are noisy and heterogeneous. We find that dark pools function as buffer zones to mitigate trader’s loss due to potential false signals. We discover a novel amplification effect. That is, when signal precision is high, dark pools enhance price discovery. And, when signal precision is low, dark pools impair price discovery. A better information environment reduces the likelihood of a harmful dark pool. This paper reconciles some conflicting empirical evidence and produces novel empirical predictions and regulatory suggestions on equity markets and in emerging markets