Bias in the Estimation of the Mean Reversion Parameter in Continuous Time Models

Author: 
Jun Yu
Description: 
Economics and Statistics Working Paper Series
JEL codes: 
Abstract: 
It is well known that for continuous time models with a linear drift standard estimation methods yield biased estimators for the mean reversion parameter both in Onite dis- crete samples and in large in-Oll samples. In this paper, we obtain two expressions to approximate the bias of the least squares/maximum likelihood estimator of the mean reversion parameter in the Ornstein-Uhlenbeck process with a known long run mean when discretely sampled data are available. The Orst expression mimics the bias for- mula of Marriott and Pope (1954) for the discrete time model. Simulations show that this expression does not work satisfactorily when the speed of mean reversion is slow. Slow mean reversion corresponds to the near unit root situation and is empirically real- istic for Onancial time series. An improvement is made in the second expression where a nonlinear correction term is included into the bias formula. It is shown that the nonlinear term is important in the near unit root situation. Simulations indicate that the second expression captures the magnitude, the curvature and the non-monotonicity of the actual bias better than the Orst expression.