The dynamic model includes time between trades or duration and average volume per transaction while the cross-market model adds cross option market activity and spreads in the underlying market. We find option market volume is not a significant determinant of option market spreads, which challenges the validity of volume as a proxy for liquidity and supports my theory. Option market spreads are positively related to spreads in the underlying market, again supporting our theory. However, option market duration does affect option market spreads, with very slow and very fast option markets both leading to bigger spreads. Only the fast market result would be predicted by asymmetric information theory.
Inventory models predict big spreads in slow markets.
Neither would be observed if the underlying securities market provided a perfect hedge. We interpret these mixed results to mean that the option market maker is able to only imperfectly hedge his positions in the underlying securities market. Asymmetric information costs in either market are naturally passed to the other market by market maker's hedging and therefore it is unimportant where the informed traders trade.