Unsystematic risk, also known as specific risk or diversifiable risk, is the risk that is specific to a particular company, industry or market segment. It can be reduced or eliminated through diversification. By investing in a portfolio of assets with different sources of risk, the overall risk of the portfolio can be reduced. Unsystematic risk is distinct from systematic risk, which is the risk that affects the entire market and cannot be diversified away.
Sources of unsystematic risk
A source of unsystematic risk can include factors specific to a particular company, such as changes in management, product recalls, and legal issues. It can also include factors specific to a particular industry, such as changes in government regulations, technological advancements, and shifts in consumer demand. Other examples of unsystematic risk include natural disasters, strikes or labor disputes and financial fraud. These are all factors that can affect the performance of a specific company or industry, but not the broader market.
Unsystematic risk identification
There are several ways to identify unsystematic risk:
- Company-specific analysis: This involves researching a particular company and identifying any potential risks specific to that company, such as changes in management, legal issues, or product recalls.
- Industry analysis: This involves researching a particular industry and identifying any potential risks specific to that industry, such as changes in government regulations or shifts in consumer demand.
- Diversification: Diversifying a portfolio across different companies and industries can help identify and reduce unsystematic risk. By spreading investments across a range of assets, the overall risk of the portfolio can be reduced.
- Risk management tools: Using risk management tools such as value at risk (VaR) and stress testing can help identify and quantify unsystematic risk in a portfolio.
- Monitoring news and events: Keeping an eye on news and events such as natural disasters, strikes or labor disputes, financial fraud and other events that can affect specific companies or industries.
It's important to note that some of these risks may be hard to anticipate, but by keeping a vigilant approach and monitoring the market, investors can be better equipped to identify unsystematic risks.
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