Everything about Systematic Risk totally explained
Systemic risk is the market risk or the risk that can't be diversified away, as opposed to "idiosyncratic risk", which is specific to individual stocks. It refers to the movements of the whole economy. Even if we've a perfectly diversified portfolio there's some risk that we can't avoid and this is the systemic risk. However, the systemic risk isn't the same for all securities or portfolios. Different companies respond differently to a recession or a booming economy. For example, think of the automobile industry compared to the food industry in case of a recession. Both of them will be affected negatively but food industry not as much as automobile industry.
In insurance it's difficult to obtain financial protection against "systemic risks" because of the inability of any counter-party to accept the risk. For example it's difficult to obtain
insurance for life or property in the event of
nuclear war. The essence of systemic risk is therefore the correlation of losses. "Systemic Risk" adds the important problem, that it's much more difficult to evaluate than "systemic risk". For example, while econometric estimates and expectation proxies in business cycle research led to a considerable improvement in forecasting recessions, data on "Systemic Risk" is often hard to obtain, since interdependencies and counter party risk on financial markets play a crucial role. If one bank goes bankrupt and sells all its assets, the drop in asset prices may induce liquidity problems of other banks, leading to a general banking panic.
One concern is the potential fragility of some financial markets. If the participants are trading at levels far above their capital bases, then the failure of one participant to settle trades may deprive others of
liquidity, and through a
domino effect expose the whole market to systemic risk.
Diversification
Risks can be reduced in four main ways: Avoidance, Reduction, Retention and Transfer. Systemic risk is a
risk of
security that can't be reduced through
diversification. Also sometimes called
market risk or un-diversifiable risk. Participants in the market, like
hedge funds, can themselves be the source of an increase in systemic risk and transfer of risk to them may, paradoxically, increase the exposure to systemic risk.
Regulation
One of the main reasons for regulation in the marketplace is to reduce systemic risk.
Project Risks
In the fields of
project management and
cost engineering, systemic risks include those risks that are not unique to a particular project and are not readily manageable by a project team at a given point in time. These risks may be driven by the nature of a company's project system (for example, funding projects before the scope is defined), capabilities, or culture. They may also be driven by the level of technology in a project or the complexity of a project's scope or execution strategy.
Further Information
Get more info on 'Systematic Risk'.
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