Brief Definition
Systematic risk refers to the risk that affects the entire market or economy, rather than being specific to a particular investment. It is caused by factors that affect the overall economy, such as economic conditions, interest rates, or political events. This type of risk cannot be eliminated through diversification because it affects all investments. Investors have to consider systematic risk when making investment decisions and may demand higher returns for taking on this risk.
Further Explanation
Systematic risk, also known as market risk or non-diversifiable risk, refers to the inherent risk associated with the overall market or economy that affects all investments. It is beyond the control of individual investors and cannot be eliminated through diversification. Systematic risk is caused by factors such as economic conditions, political events, interest rate fluctuations, inflation, and market-wide trends.
This type of risk affects a broad range of assets and investments simultaneously. It cannot be mitigated through diversification because it is inherent in the overall market or economy. For example, during an economic recession, most stocks and sectors tend to decline in value regardless of their specific characteristics or performance.
Investors face systematic risk because they are exposed to the general fluctuations and uncertainties of the market. To compensate for this risk, investors demand a higher return for taking on systematic risk compared to investments with less exposure to it.
Understanding systematic risk is important for investors and portfolio managers as it helps them assess the overall risk of their investments and make informed decisions about asset allocation, diversification, and risk management strategies.