Comparing Market Structures: Allocative and Informational Efficiencies of Continuous Trading, Periodic Auctions, and Dark Pools

This paper compares three market structures in a dynamic dealer-mediated market with asymmetric information about an asset’s value. The compared market structures are (i) the continuous protocol of Glosten and Milgrom (1985), where a just-arrived trader trades immediately at a bid or an ask price publicly posted by the dealer, (ii) the periodic auction, wherein trades are cleared in batches, publicly, and at regular intervals, and (iii) the dark pool, wherein a just-arrived trader trades immediately, and the dealer obfuscates past transaction prices. The comparison focuses on allocative efficiency (i.e., the total surplus from trade), informational efficiency (i.e., the payoff of a market observer who learns from prices), and unravelling (i.e., an entrant dealer’s ability to profit by offering a contract that does not conform with the prevailing market structure). The dark pool is found to have first-best allocative efficiency (under conditions), but it is informationally inefficient compared to the periodic auction. The continuous protocol is more allocatively efficient than the periodic auction when asymmetric information is small and traders are impatient. Among the three market structures, the dark pool is the least susceptible to unravelling (under conditions). The continuous protocol is most susceptible to unravelling; it unravels as long as there is any asymmetric information about the asset’s value. When the asymmetric information is absent or sufficiently small, the periodic auction unravels. ⇤[email protected], Department of Economics, University of Rochester. For comments, I thank Andrew Baynes, Boyan Jovanovic, Matthew Knowles, Arina Nikandrova, Colin Rowat, David Slichter, Andrzej Skrzypacz, and Gabor Virag.