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Essay example - Systematic Risk
Finance & Accounting
Pages 12 (3012 words)
Following the abrupt increase in home prices in the 2004-2006 period many financial institutions increased their holding of mortgages and mortgage-backed securities, whose performance was based on the timely mortgage payments made by home owners. …
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Another definition put forward by Billio et al states that “any set of circumstances that threatens the stability of or public confidence in the financial system” (2010)
Another facade of examining systematic risk is to view it from the position of assets in a given corporate entity. Smart and Megginson identify that “systematic risks simultaneously affect many different assets, whereas unsystematic risks affect just a few securities [or assets] at a time.” (2008: 225).
This definition creates a distinction between systematic and unsystematic risks. The main difference is that systematic risks affect all the assets that a given company holds at the same time. It is a pervasive financial risk that affects all the assets a firm holds. This is different from unsystematic risk which is unique to a specific class of assets. This implies that systematic risk can be eliminated by investing in different assets and balancing the financial risks of the different asset classes. This is known as diversification.
Systematic risk is unique by the fact that it cannot be controlled by diversification. It involves financial risks that are pervasive on the financial market (Smart and Megginson, 2008). That is the reason why systematic risk is described as market risk. This is because it is an inherent risk that affects all assets in the economy.
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