significant risk. This increased inventory cost leads to a larger bid-ask spread and reduced liquidity in each market (Stoll, 1978). In contrast, consider having a common market maker serve both markets. Simultaneously taking large short positions in both the call option and put options is less risky than shorting only one option. As the underlying variable fluctuates, the price of the call and that of the put move in the opposite direction. Therefore, holding the call option can partly offset the risk of holding the put option and vice versa. A smaller inventory holding cost leads to a narrower bid-ask spread and enhanced liquidity in each market. This effect is called ”liquidity aggregation” because it is as if the common market maker is aggregating scarce liquidity from each market into the common pool (Lange and Economide, 2005; Baron and Lange, 2007). The ability to aggregate liquidity is particularly important in introducing a new and innovative derivatives market (Shiller, 2008). One important reason is that there is a strong network externality effect when organizing a financial market (Stoll, 1992). People want to trade at a place where other people also tend to trade (Stoll, 1992; Shiller, 2008). Thus, it is difficult for the new market to gather a sufficient number of participants above a certain threshold to ensure smooth market operation (Shiller, 2008). In this respect, Robert Shiller notes that pari-mutuel auctions can serve as the springboard for new markets (Baron and Lange 2007). This approach can help new markets aggregate sufficient liquidity to compete with previously established markets (Baron and Lange, 2007). Pari-mutuel mechanisms enhance price efficiency because information flows from one market to another through the common market maker (Baron and Lange, 2007). Prices of options with the same underlying asset or variable are closely related to one another. Hence, information in one market is relevant to the pricing of other options. Therefore, a common market maker is more efficient than market makers involved only in a single fragmented market. The common market maker can use information in multiple related markets when pricing each security. 51 8.7.2 Price Efficiency