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Systematic Risk: Listing Its Types and Examples

Learn about systemic risk, including what it is, its various types, and its examples. Plus, discover how systematic risk and unsystematic risk differ

The financial market, with its inherent uncertainties, is a complex arena where risks loom large, affecting nearly all investments across the board. Enter systematic risk, a term that encapsulates the potential for market-wide disruptions and volatility.

In this guide, we’ll discuss the nuances of systematic risk, including its multiple types and examples. We’ll also discern the differences between systematic risk and unsystematic risk.

What is systematic risk?

Systematic risk, often referred to as market risk, is an omnipresent force in the financial world, transcending individual stocks or assets to cast its shadow over entire markets or asset classes. 

Fundamentally, systematic risk is driven by macroeconomic factors, like changes in interest rates, economic growth, and inflation. These forces, beyond the control of any single investor or company, have the power to influence asset values across the entire market––from currency values and housing prices to the overall stock market. 

For example, an increase in interest rates or an economic recession can lead to a general decline in the stock market, as these events typically impact the earnings and investment environment for most companies. Similarly, geopolitical tensions or global economic sanctions can create uncertainty, leading to market volatility.

Historical events like the Panic of 1837, the Great Depression of the 1930s, and the Great Recession—also known as the Global Financial Crisis or GFC—in 2008 exemplify the profound impact of systematic risk. These crises, fueled in part by overarching economic and financial factors, led to substantial investor losses, underscoring how systematic risk can manifest both major and minor downturns.

In essence, systematic risk is the common thread tying together the fate of all investments within a particular market. Recognizing its significance is crucial for investors, who must factor it into their investment strategies and consider diversification across various asset classes and geographies to mitigate its effects.

Types of systematic risks

Systematic risk encompasses various types that collectively impact the financial markets. These risks are universally present and can’t be diversified away, making them critical for investors to understand and monitor. Here are a few key types of systematic risks:

Interest rate risk

Interest rate risk, or financial risk, arises from fluctuations in interest rates and affects the value of fixed-income securities like bonds. When interest rates rise, the market value of existing bonds falls as newer bonds with higher yields become more attractive to investors. 

In contrast, when interest rates decline, the market value of existing bonds rises. Remember, interest rate risk can have a cascading effect on the economy, impacting everything from mortgage rates to consumer spending.

Market risk

Market risk, sometimes interchangeably called undiversifiable risk, is associated with investments declining in value due to economic developments that affect the entire market. It can be triggered by events like changes in government policy, inflation, or geopolitical tensions, leading to widespread market fluctuations.

Currency risk

Currency risk, or exchange rate risk, is especially relevant to investors in international markets. It arises from changes in currency exchange rates. When the value of one currency weakens relative to another, it can affect the returns on investments (ROIs) denominated in those currencies. 

Currency risk can impact foreign stocks, bonds, and other assets. 

Political risk

Political risk concerns the potential impact of political events or decisions on financial markets, such as changes in government policies, elections, trade disputes, and international conflicts.

It can disrupt markets and affect investments, particularly in regions or industries heavily influenced by government actions. For example, trade tariffs imposed during a trade war can harm the profitability of companies reliant on international trade, hurting stock prices.

Economic risk

Economic risk relates to the broader economic conditions of a country or region, contributed by factors like inflation, unemployment rates, GDP growth, and fiscal policies. These conditions can influence investment performance, as a weak economy may lead to reduced consumer spending, corporate profit declines, and decreased investor confidence.

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Examples of systematic risk

Systematic risk has been influencing the financial markets globally for centuries. Throughout history, there have been several notable examples where such risks have significantly impacted economies and investment landscapes. 

Here are a few typical examples of systematic risk:

  • Global Financial Crisis (2008): This crisis was sparked by the housing market’s collapse in the U.S. and led to a global recession, affecting financial markets worldwide through decreased credit availability and consumer spending.

  • Dot-com bubble burst (2000): The rapid rise and subsequent fall of technology stocks at the end of the ’90s, known as the dot-com bubble, represented a market risk where excessive speculation in internet-related companies led to a widespread market crash.

  • COVID-19 pandemic (2020): The outbreak of COVID-19 caused a global economic shutdown, leading to a sharp decline in stock markets across the world. This event showed how a health crisis could become a systemic risk affecting all sectors.

  • Oil price shocks: Significant fluctuations in oil prices, such as those in the ’70s and more recently in the 2010s, have repeatedly demonstrated systemic risk, affecting global economies, particularly those heavily reliant on oil.

  • European debt crisis (2010s): The crisis, which began in Greece and spread to other European nations, highlighted systemic risk related to sovereign debt and its potential to impact the European Union's economy and, subsequently, global financial markets.

  • 9/11 terrorist attacks: The attacks on the World Trade Center and the Pentagon had an immediate impact on global stock markets, insurance, and various sectors, demonstrating how geopolitical events can constitute systemic risk.

  • Black Monday (1987): On October 19, 1987, stock markets around the world crashed, shedding a huge percentage of their value in a very short time. This crash was a stark example of how market sentiment and automated trading could contribute to systemic risk.

Systematic risk vs. unsystematic risk: Key differences

While systematic risk is inherent in the broader market and all asset classes—and stems from macroeconomic factors—unsystematic risk is entirely different. 

Unlike systematic risk, unsystematic risk, also called specific risk or idiosyncratic risk, grows out of factors unique to a particular company or industry. These might include management, supply chain issues, competitive dynamics, or even sudden product recalls. But that’s not all. Here are other differences between systematic and unsystematic risk:

Mitigating strategies                                         

Systematic risk can’t be eliminated through diversification within a single asset class. It requires broader strategies like asset allocation across different asset classes or geographical diversification. Unsystematic risk, conversely, can be significantly reduced or eliminated through diversification of investments across various companies, industries, or sectors.

Predictability and control

Systematic risk is generally difficult to predict and control due to its reliance on complex, wide-ranging external factors. Unsystematic risk, on the other hand, is often more predictable and manageable as it revolves around specific entities or sectors.

Investor implications

Systematic risk represents an inherent risk for all investors and influences the overall market performance. Unsystematic risk, however, affects only individual investors depending on their exposure to specific stocks or sectors.

Strategize efficiently with Composer and manage systematic risk

Understanding and managing systematic risk is paramount, obviously, but solutions can be harder to come by. That’s where Composer comes into the picture. With advanced tools and features, Composer plays a crucial role in helping traders navigate systematic challenges effectively. It offers handy risk assessment tools and aids investment decision-making by providing insights into how systematic risk can impact an overall portfolio. 

Explore Composer's functionalities to analyze, strategize, and optimize your investments amid the complexities of systematic risk, starting today. Composer is your trusted ally, guiding you towards more informed and strategic investment choices.

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