Systematic risk is different from the risk we all know about. Rather, it could be specific risk.

Specific risk is the risk we are much familiar about – accidents or fortuitous events. In finance, when a disaster occurs that affects only a single firm, or a small group of firms, we say that the cause of the disaster constitutes a specific risk. A disastrous event at one firm does not affect other firms. In other words, the source that caused damage to one firm does not affect other firms.

The following are some causes of specific risk:

  • Fire.

  • Manufacturing defect.

  • Dissatisfaction with the company’s products.

  • Entry of a competitor.

If you own 60 firms, the damage caused to you will be proportionately negligible. In order to decide whether to take part in a lottery with these four possible outcomes, it is customary to calculate the expected profit, but that will be explained later.

What is Systematic risk?

When any disaster simultaneously affects most of the firms in a country, or most firms in some particular sector, we say that the cause of the disaster constitutes a systematic risk, also called “market risk”. This type of risk present in the market cannot be mitigated by divesification. The greater your investment the more damage you will suffer, independent of which investments you hold. The following are some examples are:

  • Economic recession

  • Security tension

  • Inflation