Systemic Risk - Explained
What is Systemic Risk?
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Table of ContentsWhat is Systematic Risk?How Does Systematic Risk Work?
What is Systematic Risk?
Systematic risk is a market risk that affects the entirety of the market, including industries, stocks and other markets.This risk is the vulnerability or volatility that affects the market. The systematic risk is the liability of markets, industries, stocks and assets to change rapidly and unpredictably, especially for the worse. It affects market incomes, outcomes and even market returns. Although, this market risk is unavoidable but it can be mitigated through diversified strategies which include hedging and correct asset allocation.
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How Does Systematic Risk Work?
Systematic risk come in diverse forms, it can be through market investments and through other market indices. Systematic risk come along with other risks such as recession, inflation of market and stock prices, interest rate changes, wars and many others. Systematic risk alongside the above listed risks lead to volatility of markets which negatively impairs or affects the entire market. Despite that systematic risk is difficult to predict or avoid, it can be managed. For instance, if investors select a diversified range of asset classes, the effect of market risk can be minimized. This is because each asset class has distinct reaction to market changes. The Great Recession in 2008 which featured drastic and negative changes in market values is an instance of market or systematic risk. During the Great Recession, asset classes witnessed huge amount of risks and negative changes. A look at a security of portfolios beta will help discover whether the security or portfolio is heading towards investment volatility and systematic risk or otherwise. A beta measures how vulnerable an investment is when compared to the entire market. You can have a beta greater than 1, less than 1 and equal to 1, these all have different meanings. Unlike systematic risk that affects the entire market, unsystematic risk affect specific assets, securities, and stocks.