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.

What Is Systemic Risk?

While systemic risk does not have an exact definition, many have used systemic risk to describe narrow problems, such as problems in the payments system. 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.

As an example of systemic risk, the collapse of Lehman Brothers in 2008 caused major reverberations throughout the financial system and the economy. The size of Lehman Brothers and deep integration in the economy caused its collapse to result in a domino effect that generated a major risk to the global financial system.

What Is Systematic Risk?

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.

"The Great Recession" of the late 2000s is an example of systematic risk. Anyone who was invested in the market in 2008 saw the values of their investments change drastically from this economic event. This recession affected asset classes in different ways as riskier securities were sold off in large quantities, while simpler assets, such as U.S. Treasuries increased their value.

(See our article Offset Risk With Options, Futures and Hedge Funds to learn ways to hedge systematic risk.)

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