Systematic and Unsystematic Risks

The deviation from the anticipated return is caused by is explained by 2 levels of risk: systematic risks and unsystematic risks. The sum of these two main categories of risk is the total risk to which an investor is exposed to.

Systematic risk is associated with overall movements in the general market or economy and therefore is often referred to as the market risk. The market risk is the component of the total risk that cannot be eliminated through portfolio diversification. These are also known as undiversifiable risks. Many academics believe that reward for credit risk from the portfolio angle is the return for systematic risk undertaken by the lenders (because all non-systematic risk can be diversified away).

Unsystematic risks are the component of the portfolio risk that can be eliminated by increasing the portfolio size, the reason being that risks that are specific to an individual security such as business or financial risk can be eliminated by constructing a well-diversified portfolio. These are known as diversifiable risks. One example of unsystematic risk is a C.E.O. resigning from the post. It is company wide issue, not the nation or economy wide.

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