Multi-criteria Classification for Pricing European Options

This paper builds a novel multi-criteria, non-parametric classification framework in order to improve the accuracy of pricing European options. The proposed approach is based on classifying financial options according to their implied volatility, time to maturity and moneyness. Using a recent data set for the daily S&P 500 index call options traded in 2012, the multi-criteria modular neural network model demonstrates its superior out-of-sample pricing performance relative to competing parametric and non-parametric models. By observing the model’s pricing errors across various option types, the analysis provides additional insights into pricing biases and stresses the importance of selecting appropriate classification criteria.