Idiosyncratic Risk

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DEFINITION of 'Idiosyncratic Risk'

Risk that is specific to an asset or a small group of assets. Idiosyncratic risk has little or no correlation with market risk, and can therefore be substantially mitigated or eliminated from a portfolio by using adequate diversification. Research suggests that idiosyncratic risk, rather than market risk, accounts for most of the variation in the risk of an individual stock over time. Similar to unsystematic risk.

BREAKING DOWN 'Idiosyncratic Risk'

Since idiosyncratic risk is by definition generally unpredictable, investors should seek to minimize its negative impact on a portfolio by diversification or hedging.

For example, the risk of a pipeline company incurring massive damages because of an oil spill can be mitigated by investing in a broad cross-section of stocks within the portfolio.

As another example, consider a mining exploration company that is operating in a nation where the risk of nationalization is fairly high. This risk can be diversified either by investing in other mining companies that do not operate in the same nation, or can be hedged through the use of options or other hedging instruments.

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