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Systematic & Unsystematic Risk(Non-diversifiable and Diversifiable risk)

18 Aug

Diversifiable risk (also known as unsystematic risk) represents the portion of an asset’s risk that is associated with random causes that can be eliminated through diversification. It’s attributable to firm-specific events, such as strikes, lawsuit, regulatory actions, and loss of a key account. Unsystematic risk is due to factors specific to an industry or a company like labor unions, product category, research and development, pricing, marketing strategy etc.

While the non-diversifiable risk (also known as systematic risk) is the relevant portion of an asset’s risk attributable to market factors that affect all firms such as war, inflation, international incidents, and political events. It cannot be eliminated through diversification and the combination of a security’s non-diversifiable risk and diversifiable risk is called total risk.

In the other word Systematic risk is due to risk factors that affect the entire market such as investment policy changes, foreign investment policy, change in taxation clauses, shift in socio-economic parameters, global security threats and measures etc. Systematic risk is beyond the control of investors and cannot be mitigated to a large extent. In contrast to this, the unsystematic risk can be mitigated through portfolio diversification. It is a risk that can be avoided and the market does not compensate for taking such risks.

However the systematic risks are unavoidable and the market does compensate for taking exposure to such risks.

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49 Comments

Posted by on August 18, 2010 in FIN, MBA

 

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