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This research advances sequential fraud detection by integrating neural variational inference into Hidden Markov Models to uncover continuous behavioral manifolds rather than discrete clusters. The study critically addresses the miscalibration between regime membership probabilities and actual fraud likelihood, proposing corrected predictive scores for better interpretability in financial transaction monitoring. While it does not surpass discriminative baselines in raw ranking metrics, the method offers a robust triage layer that combines high enrichment with structural explainability.
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Posterior Regimes and Latent Deception: Variational Bayesian Inference in Hidden Markov Models for Sequential Fraud Detection in Financial Transactions

arXiv3 min read

arXiv:2609.34031v1 Announce Type: new Abstract: We present a three-tier progression of Hidden Markov Models: maximum-likelihood (Baum-Welch), variational Bayesian (VBEM), and a neural variational extension (Neural VBEM), that model each customer's transaction history as a trajectory through a small number of latent behavioural regimes, one of which is empirically identified as fraud-associated. The Neural VBEM HMM replaces the fixed Gaussian-multinomial emission family with a learned encoder, compressing a 741-dimensional transaction representation into a 64-dimensional latent space in which the VBEM HMM's posterior operates; a UMAP projection of this space reveals that the discovered regimes are not discrete clusters but ordered segments of a single continuous behavioural manifold, with confirmed fraud concentrated at its extreme. We show that the model's natural output, that is, the posterior probability of regime membership, is routinely mistaken for a fraud probability, and quantify the resulting miscalibration (the regime-membership interpretation error, MRIE); a corrected posterior-predictive score, closes most of this gap. We further distinguish batch (smoothed) inference, which uses look-ahead unavailable at deployment time, from filtered (forward-only) inference, and report both. On IEEE-CIS transaction data, the neural tier achieves a 14.4$\times$ fraud enrichment in its identified regime; while its AUPRC trails a discriminative XGBoost baseline, we show this gap is structural and not incidental, and argue the model is best positioned as a calibrated triage and interpretability layer rather than a drop-in ranking replacement.

Abstract:We present a three-tier progression of Hidden Markov Models: maximum-likelihood (Baum-Welch), variational Bayesian (VBEM), and a neural variational extension (Neural VBEM), that model each customer's transaction history as a trajectory through a small number of latent behavioural regimes, one of which is empirically identified as fraud-associated. The Neural VBEM HMM replaces the fixed Gaussian-multinomial emission family with a learned encoder, compressing a 741-dimensional transaction representation into a 64-dimensional latent space in which the VBEM HMM's posterior operates; a UMAP projection of this space reveals that the discovered regimes are not discrete clusters but ordered segments of a single continuous behavioural manifold, with confirmed fraud concentrated at its extreme. We show that the model's natural output, that is, the posterior probability of regime membership, is routinely mistaken for a fraud probability, and quantify the resulting miscalibration (the regime-membership interpretation error, MRIE); a corrected posterior-predictive score, closes most of this gap. We further distinguish batch (smoothed) inference, which uses look-ahead unavailable at deployment time, from filtered (forward-only) inference, and report both. On IEEE-CIS transaction data, the neural tier achieves a 14.4$\times$ fraud enrichment in its identified regime; while its AUPRC trails a discriminative XGBoost baseline, we show this gap is structural and not incidental, and argue the model is best positioned as a calibrated triage and interpretability layer rather than a drop-in ranking replacement.

44 pages, 10 figures. Adapted from the primary author's MSc dissertation, University of Stirling, Scotland

Machine Learning (cs.LG); Machine Learning (stat.ML)

arXiv:2609.34031 [cs.LG]

(or arXiv:2609.34031v1 [cs.LG] for this version)

https://doi.org/10.48550/arXiv.2609.34031 Focus to learn more arXiv-issued DOI via DataCite (pending registration)

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Full text under the publisher's open licence · 334 words

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