Definition
Unsystematic risk (specific risk or idiosyncratic risk) is unique to individual companies or industries and can be reduced or eliminated through diversification. Sources include management decisions, product recalls, lawsuits, competitive threats, and regulatory changes affecting specific firms. A well-diversified portfolio (typically 20-30 stocks across sectors) effectively eliminates unsystematic risk. Because this risk can be diversified away, financial theory suggests investors should not be compensated for bearing it.
Example
A pharmaceutical company's stock drops 30% when its key drug fails FDA approval. This is unsystematic risk - a diversified portfolio with many healthcare and non-healthcare stocks would barely feel this single-stock impact.
FAQ
What is Unsystematic Risk?
Company-specific risk that can be reduced through diversification.
Why is Unsystematic Risk important?
Unsystematic Risk helps investors evaluate risk metrics and make more informed decisions.