🎲risk-return
Systematic vs Unsystematic Risk
Systematic Risk vs Unsystematic Risk
Systematic risk affects all securities and cannot be diversified away. Unsystematic risk is firm-specific and eliminated through diversification.
Comparison Table
| Feature | Systematic Risk | Unsystematic Risk |
|---|---|---|
| Also called | Market risk, non-diversifiable | Firm-specific, diversifiable, idiosyncratic |
| Examples | Interest rates, inflation, recession | CEO scandal, product recall, lawsuit |
| Diversification | Cannot be eliminated | Eliminated with 20-30 stocks |
| Measured by | Beta | Residual standard deviation |
| Compensated? | Yes, via risk premium | No, because it can be diversified away |
Key Differences
- →Systematic risk is priced in the market; unsystematic is not
- →Beta captures systematic risk only
- →A well-diversified portfolio has near-zero unsystematic risk
When to Use Systematic Risk
- ✓CAPM calculations
- ✓Understanding market-wide movements
- ✓Setting required returns
When to Use Unsystematic Risk
- ✓Analyzing individual company risk
- ✓Understanding why diversification works
- ✓Evaluating concentrated portfolios
Common Confusions
- !Thinking all risk is rewarded with return
- !Using standard deviation for a diversified portfolio's risk premium (use beta)
FAQs
Common questions about this comparison
Yes, you bear all of it. But the market does not compensate you for it because you could diversify.