Unsystematic risk definition
/What is Unsystematic Risk?
Unsystematic risk is a hazard that is specific to a business or industry. The presence of unsystematic risk means that the owner of a company's securities is at risk of adverse changes in the value of those securities because of the risk associated with that organization. An investor may be aware of some of the risks associated with a specific company or industry, but there are always additional risks that will crop up from time to time.
How to Reduce Unsystematic Risk
Unsystematic risk can be reduced by diversifying your investments across multiple industries. By doing so, the risks associated with each security in the portfolio will tend to cancel each other out. The best way to reduce unsystematic risk is to diversify broadly. For example, you could invest in securities originating from a number of different industries, as well as by investing in government securities. The use of diversification will still subject you to systemic risk, which is risks that impact the market as a whole. Thus, an increase in interest rates could result in the market values of all stocks going down (systemic risk), but would not result in an increased hazard to a specific industry (unsystematic risk).
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Examples of Unsystematic Risk
Examples of unsystematic risk are as follows:
A change in regulations that impacts one industry
The entry of a new competitor into a market
A company is forced to recall one of its products
A company is found to have prepared fraudulent financial statements
A union targets a company for an employee walkout
A foreign government expropriates the assets of a specific company
The Difference Between Systematic and Unsystematic Risk
Systematic risk is the risk that affects the entire market or a broad range of assets, and it cannot be eliminated through diversification. It is caused by factors such as economic recessions, interest rate changes, inflation, or political instability that impact most or all companies. Unsystematic risk, on the other hand, is specific to a particular company, industry, or sector and can be reduced or eliminated through diversification. Examples of unsystematic risk include company management decisions, product recalls, or industry-specific events. In summary, systematic risk is market-wide and unavoidable, while unsystematic risk is company-specific and can be managed by holding a diversified portfolio.