Microstructure noise and idiosyncratic volatility anomalies in cryptocurrencies

Cryptocurrencies have been historically characterised by large price swings and inherent volatility at a much higher scale than traditional financial assets. Understanding the underlying mechanisms and whether, or how, these are priced in through possible risk premia is crucial to bringing cryptocurrencies closer to mainstream financial markets. Using data on 1982 cryptocurrencies form January 1, 2015 till September 30, 2020 and a combination of models involving portfolio-level and Fama-MacBeth analyses, while accounting for cryptocurrency sample selection, we show that the additional risk measured by idiosyncratic volatility is well priced in cryptocurrencies and investors are being paid a risk premium for their holdings. However, a deeper inspection of the dynamics reveals that such a trade-off is mostly valid for the most illiquid cryptocurrencies, which are susceptible to microstructure noise.