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In finance, systematic risk, also sometimes called market risk, aggregate risk, or undiversifiable risk, is the risk associated with overall aggregate market returns. Systematic risk is a risk of security that cannot be reduced through diversification. It should not be confused with systemic risk, which is the risk that the entire financial system will collapse as a result of some catastrophic event, not to any individual's entity.
In the capital asset pricing model, the rate of return required for an asset in market equilibrium depends on the systematic risk associated with returns on the asset, that is, on the covariance of the returns on the asset and the aggregate returns to the market. Risk in asset returns that is uncorrelated with aggregate market returns is called 'specific risk', 'diversifiable risk', or 'idiosyncratic risk'. Given diversified holdings of assets, each individual investors exposure to idiosyncratic risk associated with any particular asset is small and uncorrelated with the rest of their portfolio. Hence, the contribution of idiosyncratic risk to the riskiness of the portfolio as a whole is negligible. It follows that only systematic risk needs to be taken into account.
Unsystematic risk
In contrast, unsystematic risk is that company or industry specific risk that is inherent in each investment one makes. The amount of unsystematic risk present can be eradicated through appropriate diversification. For example: Suppose you have $100,000 to invest, and you put it all into a single biotechnology company. The company, say X Inc, suffers a major setback in one of its experiments, and goes into huge losses. This event is company specific, and reduces your wealth. However, if one invests $10,000 in 10 different biotechnology companies, the probability of wealth reduction due to unforeseen events or setbacks is reduced considerably. Also known as "specific risk", "diversifiable risk" or "residual risk", this risk can be defined as that part of a risk which is not correlated with general market movements.[1]
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