What is the difference between systemic risk and systematic risk?

By Joseph Nguyen AAA
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. Does it make sense to convert a Traditional IRA to a Roth when the market’s down?

    If your modified adjusted gross income (MAGI) is $100,000 or less and you are not married filing separately, you may initiate ...
  2. Where does stimulus economics come from?

    Depending on which type of economist you talk to, stimulus economics originated from the ideas of either a book published ...
  3. What is the difference between arbitrage and speculation?

    Arbitrage and speculation are very different strategies. Arbitrage involves the simultaneous buying and selling of an asset ...
  4. Which day is known as China's "Black Tuesday" and why?

    On February 27, 2007, the Chinese stock market suffered a correction, causing choppy markets all over the world. The Shanghai ...
RELATED TERMS
  1. Compound Annual Growth Rate - CAGR

    The year-over-year growth rate of an investment over a specified ...
  2. Return On Investment - ROI

    A performance measure used to evaluate the efficiency of an investment ...
  3. Pension Risk Transfer

    When a defined benefit pension provider offloads some or all ...
  4. Multibank Holding Company

    A company that owns or controls two or more banks. Mutlibank ...
  5. Short Put

    A type of strategy regarding a put option, which is a contract ...
  6. Global Recession

    An extended period of economic decline around the world. The ...
comments powered by Disqus
Related Articles
  1. The Government And Risk: A Love-Hate ...
    Insurance

    The Government And Risk: A Love-Hate ...

  2. Hypothesis Testing in Finance: Concept ...
    Active Trading Fundamentals

    Hypothesis Testing in Finance: Concept ...

  3. Is Your Psyche Ready For A Bull Market?
    Active Trading Fundamentals

    Is Your Psyche Ready For A Bull Market?

  4. Can Good News Be A Signal To Sell?
    Fundamental Analysis

    Can Good News Be A Signal To Sell?

  5. Hedge Fund Fees: Exotic Expenses
    Investing Basics

    Hedge Fund Fees: Exotic Expenses

Trading Center