Information Asymmetry Effect and FX Options Bid-Ask Spreads

This paper investigates the information asymmetry effect on bid-ask spreads of dollar-euro currency options traded in over-the-counter market. We use a composite indicator of systemic stress (CISS) as a proxy for the information asymmetry effect and find that the impact of CISS on bid-ask spread is positive and significant during volatile periods when traders are asymmetrically informed. Further, for options with maturities of less than six months, we also find a positive significant relationship between bid-ask spreads and the ECB's monetary policy announcements, suggesting informed option trading before, during and after such announcements. For longer-dated options, our result suggests that the information asymmetry effect is less pronounced in the bid-ask spreads. These results are confirmed using the Glosten and Milgrom (1985) model