Risks

Idiosyncratic risk

Idiosyncratic risk (also called unsystematic risk or specific risk) is the type of risk that is unique to a particular company, industry, or asset.

It is not caused by overall market movements, and it can usually be reduced or eliminated through diversification..

Examples

• A company’s CEO suddenly resigns
• A factory catches fire
• A product recall
• Fraud or accounting errors
• Industry-specific regulation impacting one sector only

Why it matters in finance

• In portfolio theory, investors are not rewarded for taking idiosyncratic risk, because it can be avoided by holding a diversified portfolio.
• Only systematic risk (market risk) earns a risk premium.

Systematic risk

Systematic risk (also called market risk) is the type of risk that affects the entire market, not just one company or industry.

It arises from broad economic forces that cannot be avoided, even with diversification.

Systematic risk = market-wide risk you cannot escape, no matter how many different stocks you own.

Examples of systematic risk

• Recession
• Interest rate changes (e.g., central banks raising rates)