Loading the player...

What is 'Idiosyncratic Risk'

Idiosyncratic risk, also referred to as unsystematic risk, is the risk that is endemic to a particular asset such as a stock and not a whole investment portfolio. Being the opposite of systematic risk (the overall risk that affects all assets like fluctuations in the stock market or interest rates), Idiosyncratic risk can be mitigated through diversification in an investment portfolio.

BREAKING DOWN 'Idiosyncratic Risk'

Idiosyncratic risk can be thought of as the factors that affect an asset such as a stock and its underlying company at the microeconomic level. 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 accounts for most of the variation in the risk of an individual stock over time rather than market risk. Since idiosyncratic risk is by definition generally unpredictable, investors seek to minimize its negative impact on an investment portfolio by diversification or hedging.

Systematic risk is the macroeconomic factors that affect not just a single asset but other assets like it and greater markets and economies as well. Systematic risk cannot be eliminated by adding more and more assets to a portfolio. For example, market risk cannot be eliminated by adding stocks of various sectors to an investment portfolio regardless of their number.

Examples of Idiosyncratic Risk

All pipeline companies, and their stocks, face the idiosyncratic risk that their pipelines may become damaged, leak oil and bring about repair expenses, lawsuits or fines from government agencies. Unfortunate circumstances like these may cause the company to decrease distributions to investors and cause the stock to fall in price. 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. A macroeconomic factor, however, cannot be diversified away as it affects not only pipeline stocks but all stocks. If interest rates rise, for example, the value of a pipeline company's stock will likely fall in line with all other stocks. That is systematic risk.

Another example of idiosyncratic risk is a company's dependence on the CEO. When Apple CEO and co-founder, Steve Jobs, fell ill and took a leave of absence from the company, Apple's stock continued to appreciate in absolute terms, but its valuation relative to price multiples fell. After Jobs passed away, Apple's stock traded lower. Jobs was known for being a visionary and turning around Apple; as such, his leadership was part of Apple's success and ultimately its stock price.

Common Idiosyncratic Risks

Company management's decisions on financial policy, investment policy and operations are all idiosyncratic risks specific to a particular company and stock. Other examples can include location of operations and company culture. In contrast, nonidiosyncratic risks may include interest rates, inflation, economic growth or tax policy.

  1. Market Risk

    Market risk is the possibility of an investor experiencing losses ...
  2. Price Risk

    The risk of a decline in the value of a security or a portfolio. ...
  3. Country Risk

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

    Accepting risk occurs when a business acknowledges that the potential ...
  5. Operational Risk

    A form of risk that summarizes the risks a company or firm undertakes ...
  6. Business Risk

    The possibility that a company will have lower than anticipated ...
Related Articles
  1. Investing

    How To Manage Portfolio Risk

    Follow these tips to successfully manage portfolio risk.
  2. Financial Advisor

    Why Liquidity Matters in the Corporate Bond Market

    Professional analysis and constant monitoring of liquidity risk when investing in corporate bonds is highly important.
  3. Investing

    Understand Risk Before You Diversify

    Before investors can use diversification to maximize investment returns, they need to understand unsystematic risk and systematic risk.
  4. Trading

    Bettering Your Portfolio With Alpha And Beta

    Increase your returns by creating the right balance of both these risk measures.
  5. Insights

    How to Invest In Developing Markets

    Developing markets can be attractive additions to many investor's portfolios, but carry additional risks that must be considered.
  6. Investing

    The Risks Associated with Common Investments

    Investing inherently involves some risk. Here are some of the different types of investment risks.
  7. Investing

    How to Diversify Your Portfolio Beyond Stocks

    Find out how to get diversified in asset classes beyond stocks to reduce portfolio risk. Learn how diversification can help you reach your financial goals.
  8. Managing Wealth

    Why Companies Need Risk Management

    Implementing risk management strategies can save an entire organization from failure. Is yours up to snuff?
  9. Investing

    Diversification: The Right Way to Manage Risk

    Diversifying your portfolio across multiple asset classes will help you minimize investment risk.
  1. What are the primary sources of market risk?

    Learn about market risk and the four primary sources of market risk including equity, interest rate, foreign exchange and ... Read Answer >>
  2. What is the difference between risk avoidance and risk reduction?

    Learn what risk avoidance and risk reduction are, what the differences between the two are, and some techniques investors ... Read Answer >>
  3. Why are mutual funds subject to market risk?

    Find out why mutual funds, like all investments, are subject to market risk, including how the different types of market ... Read Answer >>
  4. What are some examples of risk management techniques?

    Understand what risk management is in business and why it is a necessary component of ongoing business planning, and review ... Read Answer >>
Hot Definitions
  1. Entrepreneur

    An Entrepreneur is an individual who founds and runs a small business and assumes all the risk and reward of the venture. ...
  2. Money Market

    The money market is a segment of the financial market in which financial instruments with high liquidity and very short maturities ...
  3. Perfect Competition

    Pure or perfect competition is a theoretical market structure in which a number of criteria such as perfect information and ...
  4. Compound Interest

    Compound Interest is interest calculated on the initial principal and also on the accumulated interest of previous periods ...
  5. Income Statement

    A financial statement that measures a company's financial performance over a specific accounting period. Financial performance ...
  6. Leverage Ratio

    A leverage ratio is any one of several financial measurements that look at how much capital comes in the form of debt, or ...
Trading Center