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Systematic and Unsystematic Risk

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Niranjan Patil
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7 views1 page

Systematic and Unsystematic Risk

Uploaded by

Niranjan Patil
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Systematic and Unsystematic Risk

One way academic researcher’s measure investment risk is by looking at stock price volatility. Two
risks associated with stocks are systematic risk and unsystematic risk. Systematic risk, also known
as market risk, cannot be reduced by diversification within the stock market. Sources of systematic
risk include: inflation, interest rates, war, recessions, currency changes, market crashes and downturns
plus recessions. Because the stock market is unpredictable, systematic risk always exists.

Systematic risk is largely due to changes in macroeconomics. Reducing systematic risk can lower
portfolio risk; using asset classes whose returns are not highly correlated (e.g., quality bonds, stocks,
fixed-rate annuities, etc.). It is possible to have higher risk-adjusted returns without having to accept
additional risk, a process called portfolio optimization.

Unsystematic risk, also known as company-specific risk, specific risk, diversifiable risk, idiosyncratic
risk, and residual risk, represents risks of a specific corporation, such as management, sales, market
share, product recalls, labor disputes, and name recognition. This type of risk is peculiar to an asset, a
risk that can be eliminated by diversification.

The portfolio’s risk (systematic + unsystematic) is measured by standard deviation, variation of


the mean (average, not annualized) return of a portfolio’s returns.

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