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Divide by n, n minus 1, or n plus 1?

Asked at DE Shaw

For nn i.i.d. draws from N(μ,σ2)N(\mu, \sigma^2), consider estimating σ2\sigma^2 by σ^c2=1ci=1n(XiXˉ)2\hat\sigma^2_c = \frac{1}{c}\sum_{i=1}^n (X_i - \bar X)^2. Three common choices of cc: n1n-1 (unbiased), nn (the MLE), and a mystery third option.

Which divisor cc minimizes the mean squared error of σ^c2\hat\sigma^2_c? Rank the three.

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Let S=(XiXˉ)2S = \sum(X_i - \bar X)^2. Then S/σ2χn12S/\sigma^2 \sim \chi^2_{n-1}, so E[S]=(n1)σ2E[S] = (n-1)\sigma^2 and Var(S)=2(n1)σ4\operatorname{Var}(S) = 2(n-1)\sigma^4. Write MSE as variance plus squared bias and minimize over cc.

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