Ask Eve Online players how well that works out for them. I've talked to several people who used to play, and the lag was a significant factor in their departure. They also are among the people who don't think DDO's lag is bad at all.
2.) Go the route like Eve have everyone in the same dimension. Use the servers as parallel processors instead. Allow multiple instances in each map such that some one can find an instance if they want thats unpopulated or populated. People who want to join an lfm have much more to choose from or those who like to solo can still do so. <-- In my opinion the best option.