Idiosyncratic Risk

AAA

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.

INVESTOPEDIA EXPLAINS '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.

RELATED TERMS
  1. Unsystematic Risk

    Company or industry specific risk that is inherent in each investment. ...
  2. Time-Period Basis

    An implication surrounding the use of time-series data in which ...
  3. Diversification

    A risk management technique that mixes a wide variety of investments ...
  4. Asymmetric Volatility Phenomenon ...

    The asymmetric volatility phenomenon (sometimes known as AVP) ...
  5. Maximum Drawdown (MDD)

    The maximum loss from a peak to a trough of a portfolio, before ...
  6. Gross Exposure

    The absolute level of a fund's investments.
RELATED FAQS
  1. What is the difference between systemic risk and systematic risk?

    Systemic risk is generally used in reference to an event that can trigger a collapse in a certain industry or economy, whereas ... Read Full Answer >>
  2. What is a "linear" exposure in Value at Risk (VaR) calculation?

    A linear exposure in the value-at-risk, or VaR, calculation is represented by positions in stocks, bonds, commodities or ... Read Full Answer >>
  3. How does the risk of investing in the aerospace sector compare to the broader market?

    Investing in the aerospace sector is riskier than investing in the broader market. The most accurate measure of sector volatility, ... Read Full Answer >>
  4. Do any markets not exhibit asymmetric information?

    Asymmetric information, when interpreted literally, means that two parties to an economic transaction have different information ... Read Full Answer >>
  5. Can small investors buy collateralized mortgage obligations (CMOs)?

    Collateralized mortgage obligations (CMOs), which are pools of mortgage-backed securities (MBS), are available to smaller ... Read Full Answer >>
  6. How does a pension income drawdown work?

    While there are similar drawdown plans in the United States, a pension income drawdown plan most commonly refers to a specific ... Read Full Answer >>
Related Articles
  1. Investing Basics

    Determining Risk And The Risk Pyramid

    Many investors do not understand how to determine the risk level their individual portfolios should bear.
  2. Investing Basics

    Introduction To Investment Diversification

    Reducing risk and increasing returns in your portfolio is all about finding the right balance.
  3. Options & Futures

    Bettering Your Portfolio With Alpha And Beta

    Increase your returns by creating the right balance of both these risk measures.
  4. Options & Futures

    Currency ETFs Simplify Forex Trades

    Reduce your stock portfolio's risk by trading with foreign currencies.
  5. Options & Futures

    Adding Alpha Without Adding Risk

    Learn how to generate higher returns in your portfolio while keeping the same risk profile.
  6. Retirement

    Risk And Diversification

    Safeguarding your portfolio involves a few simple steps.
  7. Investing

    The Case For Stocks Today

    Last week, U.S. equities advanced with the S&P 500 Index notching new records. Investors are now getting nervous with rate and currency volatility spiking.
  8. Investing

    Financial Gifts For Grads: Kindergarten To College

    If you really want to help your grad preparing for the future, consider a present that supports their long-term goals—an early start to financial planning.
  9. Mutual Funds & ETFs

    Why You May Want To Be (And Stay) In Bonds

    Bonds are complicated, and it’s easy to feel intimidated or confused. Fortunately, you don’t need to be a numbers geek to be an informed investor.
  10. Trading Strategies

    How To Cover Your Bases After Making A Trade

    Follow up your trade entry with these time-tested risk management strategies.

You May Also Like

Hot Definitions
  1. Moving Average - MA

    A widely used indicator in technical analysis that helps smooth out price action by filtering out the “noise” from random ...
  2. Yield Curve

    A line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity ...
  3. Productivity

    An economic measure of output per unit of input. Inputs include labor and capital, while output is typically measured in ...
  4. Variance

    The spread between numbers in a data set, measuring Variance is calculated by taking the differences between each number ...
  5. Terminal Value - TV

    The value of a bond at maturity, or of an asset at a specified, future valuation date, taking into account factors such as ...
  6. Rule Of 70

    A way to estimate the number of years it takes for a certain variable to double. The rule of 70 states that in order to estimate ...
Trading Center