Meaning of Unsystematic Risk
Unsystematic risk is unique to a given business or industry. It is also known as specific risk, nonsystematic risk, residual risk, or diversifiable risk.
Unsystematic risk is caused due to internal factors; it can be avoided and controlled. Unsystematic risk can be minimised by diversification in the sense of an investment portfolio.
Understanding Unsystematic Risk In Detail
Unsystematic risk can be defined as the inherent uncertainty of an investment in a firm or industry. Types of unsystematic risk comprise a new market competitor with the ability to take substantial market share from the company being invested in, a regulatory change (which could bring down business sales), a management shift, and/or a product recall.
Examples include events, such as legal procedural consequences, strikes, or natural disasters. This risk is also called a diversifiable risk, as it can be removed by proper diversification of a portfolio. There is no formula for estimating unsystematic risk. Instead, it needs to be extrapolated by excluding the systemic risk from the overall risk.
Types of Unsystematic Risks
Unsystematic risks are further divided into two types: 1. Financial Risks 2. Business Risks
Unsystematic Risk Example
Unsystematic risks are often related to entrepreneurial judgment mistakes. A technology company, for example, may conduct market research and anticipate the demand for smaller mobile phones and digital watches to grow in the coming year. Concerning that, manufacturing lines are modified, and money is devoted to smaller products.
Nevertheless, over the next year, the company realises that consumers are more inclined towards bigger phones and watches. Thus, the inventory and machinery the company obtained will later sell or remain unsold at a major loss. This will, in turn, have an impact on the firm's stock prices. Hence, due to poor entrepreneurial foresight, all other firms in the technology sector could perform well, while this company will backtrack.
