Nondiversifiable Risk
Nondiversifiable risk, also known as systematic risk or market risk, is the risk that is inherent in the overall market or economy. It cannot be eliminated through diversification because it affects all companies and investments.
Key Facts
- Nondiversifiable risk, also known as systematic risk or market risk, refers to the risk that is inherent in the overall market or economy. It cannot be eliminated through diversification because it affects all companies and investments.
- Diversifiable risk, also known as unsystematic risk or specific risk, is the risk that is unique to a specific company or industry. It can be reduced through diversification by spreading investments across different assets or sectors.
- Nondiversifiable risk is caused by factors that affect the entire market, such as changes in interest rates, inflation rates, political instability, or macroeconomic factors.
- Diversifiable risk, on the other hand, is caused by factors that are specific to a particular company or industry, such as management issues, regulatory changes, or product recalls.
- By diversifying their portfolio, investors can reduce the impact of diversifiable risk on their overall investment performance. However, they cannot eliminate nondiversifiable risk, as it is inherent in the market as a whole.
- The relationship between nondiversifiable risk and diversifiable risk is that the total risk of an investment portfolio is composed of both types of risk. Nondiversifiable risk represents the systematic risk that affects the entire market, while diversifiable risk represents the unsystematic risk that can be reduced through diversification.
Nondiversifiable risk is caused by factors that affect the entire market, such as changes in interest rates, inflation rates, political instability, or macroeconomic factors.
Diversifiable Risk
Diversifiable risk, also known as unsystematic risk or specific risk, is the risk that is unique to a specific company or industry. It can be reduced through diversification by spreading investments across different assets or sectors.
Diversifiable risk is caused by factors that are specific to a particular company or industry, such as management issues, regulatory changes, or product recalls.
Relationship Between Nondiversifiable and Diversifiable Risk
The relationship between nondiversifiable risk and diversifiable risk is that the total risk of an investment portfolio is composed of both types of risk. Nondiversifiable risk represents the systematic risk that affects the entire market, while diversifiable risk represents the unsystematic risk that can be reduced through diversification.
Sources
- What is Diversifiable Risk?
- What Is Unsystematic Risk? Types and Measurements Explained
- Total Risk, Non-Diversifiable Risk and Diversifiable Risk
FAQs
What is nondiversifiable risk?
Nondiversifiable risk is the risk that is inherent in the overall market or economy. It cannot be eliminated through diversification because it affects all companies and investments.
What is diversifiable risk?
Diversifiable risk is the risk that is unique to a specific company or industry. It can be reduced through diversification by spreading investments across different assets or sectors.
What is the relationship between nondiversifiable and diversifiable risk?
The relationship between nondiversifiable risk and diversifiable risk is that the total risk of an investment portfolio is composed of both types of risk. Nondiversifiable risk represents the systematic risk that affects the entire market, while diversifiable risk represents the unsystematic risk that can be reduced through diversification.
How can I reduce diversifiable risk?
Diversifiable risk can be reduced by spreading investments across different assets or sectors. For example, an investor could reduce their diversifiable risk by investing in a mix of stocks, bonds, and real estate.
How can I measure nondiversifiable risk?
Nondiversifiable risk can be measured using the beta coefficient. Beta measures the volatility of a stock or portfolio relative to the overall market. A beta of 1 indicates that the stock or portfolio is as volatile as the market. A beta of less than 1 indicates that the stock or portfolio is less volatile than the market. A beta of more than 1 indicates that the stock or portfolio is more volatile than the market.
How can I measure diversifiable risk?
Diversifiable risk can be measured using the standard deviation. Standard deviation measures the volatility of a stock or portfolio. A higher standard deviation indicates that the stock or portfolio is more volatile. A lower standard deviation indicates that the stock or portfolio is less volatile.
What is the difference between systematic risk and unsystematic risk?
Systematic risk is another term for nondiversifiable risk. It is the risk that affects the entire market or economy. Unsystematic risk is another term for diversifiable risk. It is the risk that is unique to a specific company or industry.
What is the importance of understanding nondiversifiable and diversifiable risk?
Understanding nondiversifiable and diversifiable risk is important for investors because it helps them to make informed investment decisions. By understanding the different types of risk, investors can develop a portfolio that meets their individual risk tolerance and investment goals.