What is Unsystematic Risk?

1754 reads · Last updated: December 5, 2024

Unsystematic Risk, also known as specific risk or company risk, refers to the risk that affects a particular company or industry rather than the entire market. This type of risk can be mitigated or eliminated through portfolio diversification. Examples of unsystematic risk include changes in company management, product recalls, industry regulation changes, and actions by competitors. Since unsystematic risk is specific to a particular company or industry, investors can diversify their investments across different companies' stocks to reduce this risk.

Definition

Unsystematic risk refers to the risk that affects a specific company or industry, rather than the entire market. This type of risk can be reduced or eliminated through a diversified investment portfolio. Examples of unsystematic risk include changes in company management, product recalls, changes in industry regulations, and actions by competitors. Since unsystematic risk is specific to a particular company or industry, investors can diversify this risk by investing in stocks of different companies.

Origin

The concept of unsystematic risk originated from modern portfolio theory, which was introduced by Harry Markowitz in the 1950s. Markowitz's research demonstrated that by diversifying a portfolio, investors could reduce the risk associated with specific companies or industries without affecting the overall market risk.

Categories and Features

Unsystematic risk can be categorized into company-specific risk and industry-specific risk. Company-specific risk involves internal factors of an individual company, such as management changes or financial issues. Industry-specific risk involves changes affecting an entire industry, such as new regulations or technological advancements. The main feature of unsystematic risk is its controllability, as investors can reduce this risk through diversification.

Case Studies

A typical case is the 2009 Toyota recall event. Due to brake system issues, Toyota had to recall millions of vehicles, negatively impacting its stock price. However, this event did not affect the overall performance of the automotive industry. Another example is the 2018 Facebook data breach incident, which led to a significant drop in Facebook's stock price but had limited impact on other tech companies.

Common Issues

Investors often confuse unsystematic risk with systematic risk. Unsystematic risk can be managed through diversification, whereas systematic risk involves overall market fluctuations and cannot be eliminated through diversification. Additionally, investors may underestimate the impact of unsystematic risk on individual investments, overlooking the importance of diversification.

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