[2603.04441] Explainable Regime Aware Investing

Quantitative Finance > Portfolio Management arXiv:2603.04441 (q-fin) [Submitted on 21 Feb 2026] Title:Explainable Regime Aware Investing Authors:Amine Boukardagha View a PDF of the paper titled Explainable Regime Aware Investing, by Amine Boukardagha View PDF HTML (experimental) Abstract:We propose an explainable regime-aware portfolio construction framework based on a strictly causal Wasserstein Hidden Markov Model. The model combines rolling Gaussian HMM inference with predictive model-order selection and template-based identity tracking using the 2-Wasserstein distance between Gaussian components. This allows regime complexity to adapt dynamically while preserving stable economic interpretation. Regime probabilities are embedded into a transaction-cost-aware mean-variance optimization framework and evaluated on a diversified daily cross-asset universe. Relative to equal-weight and SPX buy-and-hold benchmarks, the Wasserstein HMM achieves materially higher risk-adjusted performance with Sharpe ratios of 2.18 versus 1.59 and 1.18 and substantially lower maximum drawdown of negative 5.43 percent versus negative 14.62 percent for SPX. During the early 2025 equity selloff labeled Liberation Day, the strategy dynamically reduced equity exposure and shifted toward defensive assets, mitigating peak-to-trough losses. Compared to a nonparametric KNN conditional-moment estimator using the same features and optimization layer, the parametric regime model produces materially lower t...