Nonsystematic risk

(redirected from Diversifiable Risks)

Nonsystematic risk

Nonmarket or firm-specific risk factors that can be eliminated by diversification. Also called unique risk or diversifiable risk. Systematic risk refers to risk factors common to the entire economy.

Nonsystematic Risk

Risk that is unique to a certain asset or company. An example of nonsystematic risk is the possibility of poor earnings or a strike amongst a company's employees. One may mitigate nonsystematic risk by buying different of securities in the same industry and/or by buying in different industries. For example, a particular oil company has the diversifiable risk that it may drill little or no oil in a given year. An investor may mitigate this risk by investing in several different oil companies as well as in companies having nothing to do with oil. Nonsystematic risk is also called diversifiable risk. See also: Undiversifiable risk.

Nonsystematic risk.

Nonsystematic risk results from unpredictable factors, such as poor management decisions, successful competitive products, or suddenly obsolete technologies that may affect the securities issued by a particular company or group of similar companies.

Portfolio diversification, which means spreading your investment among a number of asset subclasses and individual issuers within those subclasses, can help counter nonsystematic risk.

References in periodicals archive ?
For the firms with access to the global stock market, the use of the Sharpe-Lintner-Mossin CAPM that presumes market segmentation (Bekaert & Harvey, 1995) will tend to overestimate the cost of equity, since diversifiable risks in a local market investment could now be diversified internationally (Stulz, 1999).
1986: Diversifiable risks in LDC lending: A 20/20 hindsight view.
As seen, the diversifiable risk component [w.sub.i.sup.2] will become smaller as securities are added to tire portfolio.
Fama and French argue that high average returns on small cap stocks and high book to market ratio stocks reflect unidentified state variables that produce non diversifiable risks in returns and that are not captured by the market return and are priced separately from market beta.
Even worse, although covariant risks are difficult for any community to manage efficiently, research has also shown the informal risk-sharing mechanisms used by the poor are inefficient even for idiosyncratic, diversifiable risks (see, e.g., Jalan and Ravallion, 1999).
By shielding directors from liability, the business judgment rule enables directors to ignore the diversifiable risks associated with various investment options and focus on expected value, which increases shareholder wealth.
Diversified shareholders "are indifferent to the levels of diversifiable risk associated with different projects." (72) They "view projects with identical levels of market risk and identical levels of expected returns as equivalent, even if the projects have very different levels of diversifiable risk." (73) For example, suppose that a corporation can choose between two potential projects.
For specific investment asset in a particular country, at least part of the political risks resulting from political violence-related policy changes are not diversifiable risks. This is because investors cannot fully anticipate all contingencies and because the market for the securitization of political risks is not yet well developed; John Finnerty, "Securitizing Political Risk Insurance: Lessons From Past Securitization" in International Political Risk Management, ed.
The diversifiable risks tend to be those more closely related to specific companies or securities, such as management risk and default risk.
Insurance is designed to build portfolios of diversifiable risks and to hedge the systematic risk in these portfolios.
Diversifiable risks are those risks that may be protected against by using the law of large numbers.
Understanding the meaning of diversifiable and nondiversifiable risks may encourage the use of asset allocation (see Chapter 6) and other portfolio techniques to minimize diversifiable risk in funds used for retirement income.