systemic risk
(noun)
The risk of collapse of an entire financial system or entire market.
(noun)
Refers to the risk common to all securities which cannot be diversified away.
Examples of systemic risk in the following topics:
-
Portfolio Diversification and Weighting
- In finance, there are two types of risk – systemic risk and specific risk.
- Systemic risk is essentially the risk that the markets will experience in a downturn and all investments within that market will be negatively affected.
- Specific risk is the risk associated with one individual security.
- The risk associated with the one mountain is called "specific risk. " The risk of bad weather, in this example, is systemic risk.
- The idea of eliminating risk by spreading investments across pools of underlying stocks and bonds is called "diversification. " A diversified portfolio spreads investments across all asset classes with a weighting system that takes time frame and risk tolerance into account.
-
Historical Returns: Market Variability and Volatility
- Inherent in all markets is something called "systemic risk. " Systemic risk is the risk of collapse of an entire financial system or entire market, as opposed to risk associated with any one individual entity, group, or component of a system.
-
Chapter Questions
- How does a firm use export creation to reduce a country risk?
- What is the Risk Rating System, and which four factors are included in this system?
- Please explain whether or not the Risk Rating System is objective?
- Distinguish between qualitative and quantities measures for measuring a country's risk?
-
Expected Risk and Risk Premium
- Overall riskiness of an asset is composed of its own individual risk (beta) along with its risk in relation to the market as a whole.
- A certain amount of risk is inherent in any investment.
- Systemic risk is the risk associated with an entire financial system or entire market.
- On the other hand, unsystematic risk is risk to which only specific classes of securities or industries are vulnerable.
- The term risk premium refers to the amount by which an asset's expected rate of return exceeds the risk free rate.
-
Impact of Diversification on Risk and Return: Systematic Risk
- As a result, the portion of risk that is unsystematic -- or risk that can be diversified away -- does not require additional compensation in terms of expected return.
- This type of risk cannot be diversified away, and is referred to as systematic risk.
- This is the portion of risk that pays the risk premium, because the risk associated with this particular segment of the market is more tightly linked to the risk of the market as a whole.
- This risk is present regardless of the amount of diversification undertaken by an investor.
- Diversification theory says that the only risk that earns a risk premium is that which can't be diversified away.
-
Arbitrage Pricing Theory
- The Arbitrage Pricing Theory (APT) is a linear relationship between systemic factors and the return of an asset.
- Naturally, this means that there are limits to how accurate APT is in the real world, but APT is still used as the basis for many of the commercial risk systems employed by asset managers.
- APT can also be expressed in terms of expected returns where RP is the risk premium of the factor, and rf is the risk-free rate.
-
Political, Country, and Global Specific Risks
- Although the exchange rate risk is a firm specific risk, a government does not directly impose the risk onto a business.
- Thus, they impose restrictions on banking that differs from the Western banking systems.
- Just in time inventory system that many businesses have adopted forms another global risk.
- Governments and business enterprises use large networks of computer systems to store the data.
- Computer hackers can break into these computer systems and steal or destroy the data.
-
Government Bonds
- Government bonds are sometimes regarded as risk-free bonds because national governments can raise taxes or reduce spending up to a certain point.
- Unlikely equity system, the bond secondary market uses a completely different system with different method of trading.
- There is currency risk for government bondholders.
- In this instance, the term "risk-free" means free of credit risk.
- However, other risks still exist, such as currency risk for foreign investors (for example non-U.S. investors of U.S.
-
Approaches to Assessing Risk
- Since planned actions are subject to large cost and benefit risks, proper risk assessment and risk management for such actions are crucial to making them successful.
- As risk carries so many different meanings, there are many formal methods used to assess or to "measure" risk.
- In enterprise risk management, a risk is defined as a possible event or circumstance that can have negative influences on the enterprise in question.
- In a financial institution, enterprise risk management is normally thought of as the combination of credit risk, interest rate risk or asset liability management, market risk, and operational risk.
- In project management, risk management can include: planning how risk will be managed, assigning a risk officer, maintaining a database of live risks, and preparing risk mitigation plans.
-
Reinvestment Risk
- Reinvestment risk is the risk that a bond is repaid early, and an investor has to find a new place to invest with the risk of lower returns.
- Reinvestment risk is one of the main genres of financial risk.
- Reinvestment risk is more likely when interest rates are declining.
- Pension funds are also subject to reinvestment risk.
- Two factors that have a bearing on the degree of reinvestment risk are: