A:

Systemic risk is generally used in reference to an event that can trigger a collapse in a certain industry or economy, whereas systematic risk refers to overall market risk. Systemic risk does not have an exact definition, many have used systemic risk to describe narrow problems, such as problems in the payments system, while others have used it to describe an economic crisis that was triggered by failures in the financial system. Generally, systemic risk can be described as a risk caused by an event at the firm level that is severe enough to cause instability in the financial system.

On the other hand, systematic risk does have a more recognized and universal definition. Sometimes plainly called market risk, systematic risk is the risk inherent in the aggregate market that cannot be solved by diversification. Some common sources of market risk are recessions, wars, interest rates and others that cannot be avoided through a diversified portfolio. Though systematic risk cannot be fixed with diversification, it can be hedged. Also, the risk that is specific to a firm or industry and can be solved by diversification is called unsystematic or idiosyncratic risk. (See our article Offset Risk With Options, Futures And Hedge Funds to learn ways to hedge systematic risk.)

As an example of systemic risk, the collapse of Lehman Brothers in 2008 caused major reverberations throughout the financial system and the economy. Lehman Brother's size and integration in the economy caused its collapse to result in a domino effect that caused a major risk to the financial system in the U.S.

For a complete review of the Lehman failure, take a look at our case study on The Collapse of Lehman Brothers.

This question was answered by Joseph Nguyen.

RELATED FAQS
  1. How do markets account for systematic risk?

    Find out how market participants deal with systematic risk, or the kind of market risk that cannot be diversified away through ... Read Answer >>
  2. How does market risk differ from specific risk?

    Learn about market risk, specific risk, hedging and diversification, and how the market risk of assets differs from the specific ... Read Answer >>
  3. What are the key differences between financial risk and business risk to a company?

    Understand the difference between a company's financial risk and its business risk, along with some of the factors that affect ... Read Answer >>
  4. What kinds of securities are influenced most by systematic risk?

    Learn what systematic risk is, how investors can measure it with beta and how securities with a beta greater than 1 are most ... Read Answer >>
  5. What is the difference between market risk and country risk?

    Learn about market risk and country risk, some examples of each and the main difference between these two types of risks. Read Answer >>
  6. What are the major categories of financial risk for a company?

    Examine four major categories of financial risk for a business that represent potential problems that a company may have ... Read Answer >>
Related Articles
  1. Investing

    Understanding Market Risk

    Market risk is the chance that an investment’s value will decrease due to a factor that affects all investments across the market.
  2. Investing

    How To Manage Portfolio Risk

    Follow these tips to successfully manage portfolio risk.
  3. Personal Finance

    Risk Management Framework (RMF): An Overview

    A company must identify the type of risks it is taking, as well as measure, report on, and set systems in place to manage and limit, those risks.
  4. Managing Wealth

    Offset Risk With Options, Futures And Hedge Funds

    Though all portfolios contain some risk, there are ways to lower it. Find out how.
  5. Investing

    Unlevered Beta

    Learn about how this number provides a measure of how much systematic risk a firm's equity has compared to the market.
  6. Investing

    Explaining Idiosyncratic Risk

    Idiosyncratic risk is the risk inherent in a particular investment due to the unique characteristics of that investment.
  7. Investing

    Case Study: The Collapse of Lehman Brothers

    Lehman Brothers survived many financial crises in its long history. Find out what finally drove it to bankruptcy.
  8. Trading

    Trading Systems: Run With The Herd Or Be A Lone Wolf?

    Find out if taking the path less traveled will work in your favor - or against it.
  9. Small Business

    Lehman Brothers: The Largest Bankruptcy Filing Ever

    Lehman Brothers survived several crises, but the collapse of the U.S. housing market brought the company to its knees.
RELATED TERMS
  1. Systematic Risk

    The risk inherent to the entire market or entire market segment. ...
  2. Systemic Risk

    Investopedia explains: A systemic risk is the possibility that ...
  3. Specific Risk

    Risk that affects a very small number of assets. Specific risk, ...
  4. Market Risk

    The possibility for an investor to experience losses due to factors ...
  5. Country Risk

    A collection of risks associated with investing in a foreign ...
  6. Accepting Risk

    A risk management method used in the business or investment field. ...
Hot Definitions
  1. Stagflation

    A condition of slow economic growth and relatively high unemployment - a time of stagnation - accompanied by a rise in prices, ...
  2. Notional Value

    The total value of a leveraged position's assets. This term is commonly used in the options, futures and currency markets ...
  3. Interest Expense

    The cost incurred by an entity for borrowed funds. Interest expense is a non-operating expense shown on the income statement. ...
  4. Call Option

    An agreement that gives an investor the right (but not the obligation) to buy a stock, bond, commodity, or other instrument ...
  5. Pro-Rata

    Used to describe a proportionate allocation. A method of assigning an amount to a fraction, according to its share of the ...
  6. Private Placement

    The sale of securities to a relatively small number of select investors as a way of raising capital.
Trading Center