Unsystematic Risk
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.
Unsystematic 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, industry regulation changes, and actions by competitors. Since unsystematic risk is specific to a particular company or industry, investors can mitigate this risk by investing in stocks of different companies.
Origin
The concept of unsystematic risk originates from Modern Portfolio Theory (MPT), proposed by Harry Markowitz in 1952. Markowitz's theory emphasizes reducing the total risk of an investment portfolio through diversification, where unsystematic risk is the portion that can be eliminated through diversification.
Categories and Characteristics
Unsystematic risk can be categorized into the following types:
- Company-specific risk: Such as management changes, financial scandals, product recalls, etc.
- Industry-specific risk: Such as changes in industry regulations, technological innovations, changes in market demand, etc.
Characteristics:
- Controllability: Can be reduced or eliminated through diversification.
- Specificity: Affects only specific companies or industries, not the entire market.
Comparison with Similar Concepts
In contrast to unsystematic risk, systematic risk refers to the risk that affects the entire market, such as economic recessions, political instability, and natural disasters. Systematic risk cannot be eliminated through diversification.
Specific Cases
Case 1: A technology company experiences a significant drop in stock price due to management changes. If an investor holds only this company's stock, they will face substantial losses. However, if the investor holds stocks of multiple technology companies, the losses can be offset by the good performance of other companies.
Case 2: An automobile manufacturer faces a stock price drop due to a product recall event. If an investor's portfolio includes stocks of multiple automobile manufacturers, this risk can be diversified, reducing the impact on the overall investment portfolio.
Common Questions
Q: Can unsystematic risk be completely eliminated?
A: Unsystematic risk can be significantly reduced through diversification, but it is challenging to eliminate it entirely. Investors should allocate their portfolios reasonably based on their risk tolerance and investment goals.
Q: How can unsystematic risk be effectively diversified?
A: Investors can diversify unsystematic risk by investing in stocks of different companies, industries, and asset classes.
