Meaning and definition of non-systematic risk
Also referred as “specific risk”, “residual risk” or “specific risk”, non-systematic risk is the industry or company specific risk which is inherent in every investment. Putting it simple, unlike systematic risk affecting the entire market, it applies only to certain investments. Moreover, it is the element of price risk which can be eliminated largely through adequate diversification within a specific asset class. It is, therefore, the individual business risk related to underlying stock, if the company goes bankrupt, it can be stated as a non-systematic risk event and usually has little to do with the general recede and flow of the entire market.
Example of non-systematic risk
There are some examples which can be mentioned to illustrate the non-systematic risk. One of these good examples includes news that is associated with small number of stocks, like an unexpected strike by the employees of a company you hold shares of.
Estimation of non-systematic risk
Calculating non-systematic risk is not a difficult task. The procedure includes certain steps which are as follows:
- Eradicate all the systematic risks from an investment. The most effective way of doing this would be just putting up a simple question – “Can this be hedged against?” On the whole, a non-systematic risk is the one wherein the investor can prevaricate by selling short or just signing a futures contract.
- Another consideration is whether the risk can be reduced through diversification. An answer in a yes would indicate a non-systematic risk.
- Ascertain whether the management of the company being invested in can show any impact on its risk. If so, then it is considered as another non-systematic risk. Unlike non-systematic risk, systematic risk is difficult to be managed against for they have impact on the whole industries instead of single investments.
It is usually debated about the number of securities required to be held by an investor for mitigating non-systematic risk. As per researches, 30-40 securities are sufficient to mitigate non-systematic risk. A rational investor is, therefore, expected to follow measures for mitigating non-systematic risk from his portfolio by raising the number of holdings within every singular asset class.
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