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RegimeFolio: A Regime Aware ML System for Sectoral Portfolio Optimization in Dynamic Markets

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  • Yiyao Zhang
  • Diksha Goel
  • Hussain Ahmad
  • Claudia Szabo

Abstract

Financial markets are inherently non-stationary, with shifting volatility regimes that alter asset co-movements and return distributions. Standard portfolio optimization methods, typically built on stationarity or regime-agnostic assumptions, struggle to adapt to such changes. To address these challenges, we propose RegimeFolio, a novel regime-aware and sector-specialized framework that, unlike existing regime-agnostic models such as DeepVol and DRL optimizers, integrates explicit volatility regime segmentation with sector-specific ensemble forecasting and adaptive mean-variance allocation. This modular architecture ensures forecasts and portfolio decisions remain aligned with current market conditions, enhancing robustness and interpretability in dynamic markets. RegimeFolio combines three components: (i) an interpretable VIX-based classifier for market regime detection; (ii) regime and sector-specific ensemble learners (Random Forest, Gradient Boosting) to capture conditional return structures; and (iii) a dynamic mean-variance optimizer with shrinkage-regularized covariance estimates for regime-aware allocation. We evaluate RegimeFolio on 34 large cap U.S. equities from 2020 to 2024. The framework achieves a cumulative return of 137 percent, a Sharpe ratio of 1.17, a 12 percent lower maximum drawdown, and a 15 to 20 percent improvement in forecast accuracy compared to conventional and advanced machine learning benchmarks. These results show that explicitly modeling volatility regimes in predictive learning and portfolio allocation enhances robustness and leads to more dependable decision-making in real markets.

Suggested Citation

  • Yiyao Zhang & Diksha Goel & Hussain Ahmad & Claudia Szabo, 2025. "RegimeFolio: A Regime Aware ML System for Sectoral Portfolio Optimization in Dynamic Markets," Papers 2510.14986, arXiv.org.
  • Handle: RePEc:arx:papers:2510.14986
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    References listed on IDEAS

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    1. Ledoit, Olivier & Wolf, Michael, 2004. "A well-conditioned estimator for large-dimensional covariance matrices," Journal of Multivariate Analysis, Elsevier, vol. 88(2), pages 365-411, February.
    2. Guidolin, Massimo & Timmermann, Allan, 2007. "Asset allocation under multivariate regime switching," Journal of Economic Dynamics and Control, Elsevier, vol. 31(11), pages 3503-3544, November.
    3. Hamilton, James D, 1989. "A New Approach to the Economic Analysis of Nonstationary Time Series and the Business Cycle," Econometrica, Econometric Society, vol. 57(2), pages 357-384, March.
    4. William F. Sharpe, 1964. "Capital Asset Prices: A Theory Of Market Equilibrium Under Conditions Of Risk," Journal of Finance, American Finance Association, vol. 19(3), pages 425-442, September.
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    Cited by:

    1. Kefan Chen & Hussain Ahmad & Diksha Goel & Claudia Szabo, 2025. "3S-Trader: A Multi-LLM Framework for Adaptive Stock Scoring, Strategy, and Selection in Portfolio Optimization," Papers 2510.17393, arXiv.org.

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