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Idiosyncratic Risk

Idiosyncratic risk refers to the inherent factors that can negatively impact individual securities or a very specific group of assets.

Definition:

What is Idiosyncratic Risk?

In the concept of Idiosyncratic Risk, the investors can decrease, or even eliminate, the level of company-specific risk in any individual share by owning a sufficiently broad, diversified portfolio. It refers to the underlying reasons that can negatively influence single security or a small group of assets. Systematic risk is the opposite of idiosyncratic risk, and it relates to more prominent tendencies that affect the entire financial system or a vast market.

Example of Idiosyncratic Risk:

Accounting fraud, cyberattacks, loss of key personnel, or any other issue which affects a specific company without affecting the rest of the market.

Following are how idiosyncratic risks can be avoided:

  • Holding a well-diversified portfolio reduces the impact of events on individual companies in the portfolio,
  • exposes the portfolio to general market risk, and
  • follows a pattern because when investors can diversify at minimal or no cost, they do so.

Importance of Idiosyncratic Risk:

Risk Professionals must understand the broad categories of risk. There are two levels of risks involved: company-specific risk and systematic risk. Hence, it is essential to understand the idiosyncratic risk to understand the risk dimensions well.

 

Owais Siddiqui
1 min read
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