Reviewed by Jan 29, 2021| Updated on
Systemic risk refers to the risk inherent in the whole market or part of the market. Systematic risk is also called the undiversifiable risk, market risk, or volatility. It affects not just a particular stock or industry, but the overall market. This kind of risk is not only unpredictable but also it is absolutely impossible to avoid. It can not be mitigated by diversification, only by hedging or by using the proper asset allocation strategy.
To manage systematic risk effectively, investors should ensure that their portfolios include a range of asset classes, such as cash, real estate, and fixed income, each of which will react in a different way in the event of a significant systemic change. For example, an increase in interest rates will make certain new-issue bonds more valuable, while causing some corporate stocks to fall in price as investors perceive executive teams to cut spending. Ensuring that a portfolio contains enough income-generating securities in the event of an interest rate rise will minimize the loss of value in some equities.
Systemic risk can be seen as the probability of a loss associated with the entire market or a portion. Therefore, unsystematic risk refers to the possibility of a loss within a particular industry or protection. Systematic risk implies other investment-related risks, such as risks related to the industry.
The opposite of systemic risk, unsystematic risk, has an effect on a very particular securities group or individual security. Diversification may help to mitigate unsystematic risk.