Transparency in Fragmented Markets: Experimental Evidence

We experimentally examine pre-trade transparency in fragmented limit-order markets. Allowing traders to hide their orders encourages limit order usage. This improves measures of liquidity by increasing depth and narrowing spreads. However, because some of this depth is not displayed, market fragmentation may limit traders’ ability to capitalize on the improved liquidity. This happens when traders execute against displayed orders at worse prices than hidden orders in another market, often referred to as ‘trade-throughs.’ In our laboratory setting, increased trade-throughs due to a dark market impose costs of similar magnitude to the benefits of increases in depth leaving effective liquidity unchanged.