Systematic and Unsystematic Risk

The first type of surprise, the one that affects a large number of assets, we will label systematic risk. A systematic risk is one that influences a large number of assets, each to a greater or lesser extent. Because systematic risks have marketwide effects, they are sometimes called market risks.

systematic risk

A risk that influences a large number of assets. Also, market risk.

426 PART FIVE Risk and Return

The second type of surprise we will call unsystematic risk. An unsystematic risk is one that affects a single asset or a small group of assets. Because these risks are unique to individual companies or assets, they are sometimes called unique or asset-specific risks. We will use these terms interchangeably.

As we have seen, uncertainties about general economic conditions, such as GDP, interest rates, or inflation, are examples of systematic risks. These conditions affect nearly all companies to some degree. An unanticipated increase, or surprise, in inflation, for example, affects wages and the costs of the supplies that companies buy; it affects the value of the assets that companies own; and it affects the prices at which companies sell their products. Forces such as these, to which all companies are susceptible, are the essence of systematic risk.

In contrast, the announcement of an oil strike by a company will primarily affect that company and, perhaps, a few others (such as primary competitors and suppliers). It is unlikely to have much of an effect on the world oil market, however, or on the affairs of companies not in the oil business, so this is an unsystematic event.

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