Understanding Unsystematic Risk
Definition
Unsystematic risk, or specific risk, is the uncertainty tied to a specific company, sector, or industry. Unlike systematic risk, it does not affect the entire market but rather individual stocks or groups of stocks.
Characteristics
1. Localized Impact: This risk is specific to a company or sector and does not necessarily affect the broader market.
2. Diversifiable: By holding a well-diversified portfolio, you can significantly reduce unsystematic risk.
3. Examples:
1. Poor management decisions
2. Product recalls
3. Regulatory penalties
4. Sector-specific downturns (e.g., declining oil prices affecting energy companies)
Impact on Investors
Unsystematic risk can lead to significant losses if an investor’s portfolio is concentrated in a single company or sector. For example, the bankruptcy of Enron Corporation in 2001 wiped out shareholders’ investments, highlighting the dangers of unsystematic risk.