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In risk management, systematic risk refers to the risk
factors that affect financial markets as a whole, lowering stock returns and
asset liquidity. Discover the various types of systematic risks.
What Is Systematic Risk?
Systematic risk, also known as market risk or
non-diversifiable risk, refers to macroeconomic factors that have a seismic
impact on business finances. These broader business risks have a large impact
on the entire market and can have a significant impact on consumers, the stock
market, and supply and demand stability. Such financial risks cannot be
controlled or mitigated by businesses. A diversified portfolio can help
businesses reduce risk, but significant systemic risks, such as weather events
and war, can have a significant impact on various asset classes.
Systematic Risk vs. Unsystematic Risk
Systematic and unsystematic risks both speak to business
volatility, but in different ways. Systematic risks are caused by external
factors such as recession and inflation risks. These economic factors have an
impact on the overall market, and all businesses are affected. When such risks
exist, stock prices and real estate values will fall as a whole, and investment
portfolios will suffer. These dangers cannot be avoided and affect all
industries.
Internal factors that may pose risks to specific industries
are referred to as unsystematic risk. Unsystematic risks, also known as
specific risks, cause individual stocks to fall rather than affecting the
entire market segment. Unsystematic risks include labor strikes, late supply
deliveries, and other microeconomic factors unrelated to the market as a whole.
3 Types of Systematic Risk
Each type of risk necessitates a strategy for mitigating
business fluctuations.
1. Interest rate risk: Changing interest rates can have a
significant impact on fixed-income securities, such as bond and security
prices. Investors will withdraw assets from fixed-income securities as interest
rates rise.
2. Market risk: When the market is volatile, investors are
less likely to buy stocks or move money around as easily. Even when investing
in more successful companies, investors will be wary because circumstances can
change quickly.
3. Purchasing power risk: Inflation reduces consumers'
purchasing power, making them less willing to spend their disposable income. A
drop in purchasing power can have a domino effect on businesses and their
well-being.
4 Examples of Systematic Risk
While diversification and asset location can help to
mitigate risk, most types of systematic risk have a broader impact on the
market. Typical and historical examples of systemic risks include:
1. Economic decline: A prolonged economic downturn can
have an impact on employment and consumer spending. For example, the Great
Depression resulted in high unemployment and a sharp drop in GDP.
2. International affairs: Wars and famines can cause higher
inflation rates and more severe systemic risks. Because businesses boycotted
Russian oil as a result of the Ukraine invasion, gas prices rose.
3. Natural disasters: If areas flood or experience drought,
Mother Nature can cause financial crises. Two historical examples of systematic
risks are the Dust Bowl and the Irish Potato Famine.
4. Public health: A common infectious disease can pose
a systemic risk. The COVID-19 pandemic, for example, resulted in labor
shortages and seismic supply chain issues.
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