Realized Volatility Bias

Realized volatility bias occurs when the calculated historical volatility of an asset deviates from its true, latent volatility due to the sampling frequency or the presence of market noise. If a trader uses high-frequency data to calculate realized volatility without proper filtering, the resulting estimate is often inflated by the microstructure noise of the order book.

This bias can lead to incorrect pricing of derivative contracts and poor risk assessment. To mitigate this, practitioners use specialized estimators that account for the sampling interval and the noise component.

Correcting for this bias is essential for building reliable quantitative models. It ensures that the risk metrics accurately reflect the genuine price fluctuations rather than just the market's mechanical friction.