Systematic Risk Definition: Examples of Systematic Risk

Systematic risk, also known as market risk or non-diversifiable risk, describes macroeconomic factors impacting business finances with seismic shifts. These broader business risks influence the entire market and can significantly affect consumers, the stock market, and supply and demand stability. Companies cannot control or lessen such financial risks. A diversified portfolio can help companies reduce risk, but considerable systemic risks, like weather events and war, can significantly impact various asset classes.

Systematic and unsystematic risks speak to business volatility but have different localizations. External factors, such as recession and inflation risks, cause systematic risks. These economic factors affect the overall market, and all businesses experience the impact. Stock prices and real estate values, as a whole, will drop, and investment portfolios will suffer when such risks are present. These risks are unavoidable and affect all industries.

Unsystematic risk refers to internal factors that may pose risks to specific industries. Also known as specific risks, unsystematic risks will see individual stocks fall instead of affecting the larger market segment. Examples of unsystematic risks include labor strikes, delayed supply deliveries, and other microeconomic factors separate from the market at large.

Each type of risk requires strategies for hedging business fluctuations.

1. 1. Interest rate risk: Fluctuating interest rates can predominantly affect fixed-income securities, like bond and security prices. With rising interest rates, investors will pull assets out of fixed-income securities.
2. 2. Market risk: This risk happens when the market is volatile, and investors are not looking to buy stocks or move money around as readily. Investors will have trepidation even when investing in more successful companies because circumstances can quickly change.
3. 3. Purchasing power risk: Inflation lowers the buying power of consumers, making them less willing to spend disposable income. A lower purchasing power can domino effect businesses and their welfare.

While diversification and asset location can reduce risk, most types of systematic risk have overarching effects on the market. Examples of typical and historical systemic risks include:

1. 1. Economic decline: A sustained economic decline can affect employment and consumer spending. The Great Depression, for example, led to high unemployment and a sharp decrease in GDP.
2. 2. Global affairs: Wars and famines can lead to higher inflation rates and more acute systematic risks. The Ukraine invasion led to increased gas prices because businesses boycotted Russian oil.
3. 3. Natural disasters: Mother Nature can cause financial crises if areas flood or experience droughts. The Dust Bowl and the Irish Potato Famine are two historical examples of systematic risks.
4. 4. Public health: A widespread infectious disease can be a systematic risk. For example, the COVID-19 pandemic led to labor shortages and seismic supply chain issues.

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