Unsystematic Risk

Unsystematic risk affects a specific company or industry and can be reduced through diversification, unlike market-wide systematic risk.
Unsystematic Risk
3 min
09-June-2025

The stock market always has an element of risk involved. This risk can be classified into two major categories — systematic risk and unsystematic risk. Understanding what they are is crucial to making informed financial decisions. In this article, we are going to explore unsystematic risk, its various types and its relationship with systematic risk.

Unsystematic risk pertains to risks unique to a specific company rather than the broader market or industry. These risks may arise from factors such as a company’s management decisions, financial structure, or geographic location. Unlike systematic risk, unsystematic risk can be minimized through diversification of investments.

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What is unsystematic risk

Unsystematic risk, also called diversifiable risk, involves risks unique to a particular company or industry, such as those related to management, finances, or location. Unlike systematic risks that impact the entire market and are harder to avoid, unsystematic risks can be reduced by diversifying your investments.

Types of unsystematic risks

From legal and regulatory changes to operational downtimes, all kinds of uncertainties specific to a company or industry are classified as unsystematic risks. Here is a brief overview of some of the most common unsystematic risk types.

1. Business risk

Business risk includes all the risks that threaten a company’s revenue, profitability and overall performance. Business risk could arise due to internal factors like production disruptions or external factors like changes in consumer preferences.

2. Financial risk

Financial risk includes the risks associated with the financial structure of a company. A less-than-ideal or weak financial structure due to an incorrect or sub-optimal debt-equity mix is one of the major financial risks a company faces.

3. Regulatory risk

Regulatory risk includes disruptions that are caused due to changes in the laws, regulations and policies governing a company or an industry. A change in corporate taxation and environmental regulations are a couple of examples of regulatory risk.

4. Management risk

Management risk is the uncertainty surrounding the competency and decisions of a company's key management team. Some of the factors that contribute to management risk involve poor strategic choices, ineffective leadership and corporate governance issues.

5. Industry risk

Industry risk involves all the factors that affect an entire industry. Generally, industries that are characterised by rapid innovation and stringent regulations often have significantly higher industry risk.

6. Strategic risk

Strategic risk stems from the uncertainty surrounding the management’s business strategy. For example, a company entering into a strategic partnership with another entity at unfavourable terms is a form of strategic risk.

7. Operational risk

Operational risk involves all the factors that threaten the day-to-day operations of the company. This includes the breakdown of critical machinery, data breaches and supply chain disruptions.

Examples of unsystematic risk

Now that you have seen the various types of unsystematic risk, let us look at a couple of hypothetical examples to better understand the concept.

Imagine you invest in a manufacturing company that produces electronic goods. Due to a semiconductor shortage, the company faces supply chain disruptions, bringing its entire manufacturing facility to a halt. The uncertainty surrounding the supply chain is an operational risk, which is a type of unsystematic risk.

Alternatively, let us say that you invest in a fintech company that provides a range of financial services. A regulatory policy change by the Reserve Bank of India leads to increased scrutiny and disruption of the company’s operations. This is an example of regulatory risk.

Advantages of unsystematic risk

Although it may be surprising, unsystematic risk has a few advantages. Let us look at some of them.

  • Unsystematic risk only affects a specific company or an industry. The larger economy and the market would remain unaffected by these risks.
  • Since these risks are very specific, they may not be as severe as systematic risks. Furthermore, the impact of unsystematic risk is also much lower.
  • Unsystematic risk can be managed and mitigated to a certain extent through proper portfolio diversification.

Disadvantages of unsystematic risk

Unsystematic risk can be highly disadvantageous to investors. Understanding its drawbacks can help you manage it better. Here are a couple of key disadvantages.

  • Unsystematic risk can disrupt a specific industry even when the overall economy is performing well.
  • Although these risks are confined to a particular company or industry, recovery can take a significant amount of time, and if issues arise during this period, the disruption may be prolonged.
  • Sometimes, unsystematic risk causes permanent shifts in customer preferences, which can have serious consequences for the affected company or industry’s market position.
  • Since unsystematic risks are typically unique and non-repetitive, management faces challenges in planning effectively, as future problems may differ from past ones.
  • Such risks can severely impact employee morale, leading to job insecurity and reduced confidence among the workforce.
  • Companies may need to invest substantial time, money, and resources to manage or recover from these risks.
  • Because unsystematic risks usually affect only a limited segment and do not significantly impact the broader economy, government intervention and financial support are often minimal or absent.
  • In some cases, these risks can indirectly contribute to negative effects on the wider economy.
  • Firms that are interconnected may experience a domino effect, where problems in one company adversely affect others and related services.

Unsystematic risk vs systematic risk

Unsystematic risk refers to risks unique to a particular company or industry, whereas systematic risk—also known as market risk—relates to factors that affect the entire market. Systematic risk arises from broad economic or market conditions and impacts an investment portfolio as a whole, rather than being tied to individual assets.

Particulars Systematic risk Unsystematic risk
Scope Affects the entire market or economy Specific to a company or an industry
Management Cannot be managed or mitigated Can be managed through portfolio diversification
Source of risk Macroeconomic factors like economic indicators, interest rates and geopolitical events Company or industry-specific factors like regulatory changes and management decisions
Predictability Can be measured and predicted Cannot be accurately predicted or measured
Controllability Beyond the control of the company and investors Well within the control of the company


Conclusion

Unsystematic risks are uncertainties surrounding a specific industry or a company. Although such risks cannot be accurately predicted, they can be managed to a certain extent through portfolio diversification. However, it is essential to understand that despite strong risk management measures, unsystematic risks cannot be eliminated entirely.

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Frequently asked questions

What are the characteristics of unsystematic risk?
Unsystematic risk has certain unique characteristics that set it apart from systematic risk. These characteristics include being company or industry-specific, highly variable across companies and controllable to a certain degree through diversification.
What is the disadvantage of unsystematic risk?
The major disadvantage of unsystematic risk is that it cannot be accurately predicted. This makes it extremely challenging to quantify and manage effectively. Although it can be mitigated through diversification, the measures you implement could potentially increase costs.
Can unsystematic risks be positive?
Although it could turn out to be positive in some cases, unsystematic risk is generally perceived as a source of uncertainty and potential loss for investors. It is one of the many reasons why investors go to great lengths to mitigate it as much as possible through diversification.
Is unsystematic risk avoidable?

Unsystematic risk is diversifiable, which means it can be minimized by investing in a variety of companies across different industries. Since these risks are usually specific to individual companies or sectors, creating a well-diversified portfolio helps to avoid or reduce their impact.

What is the difference between systemic and unsystematic risk?

The key difference between unsystematic and systematic risk is that unsystematic risk impacts only a specific company or industry, while systematic risk influences all companies across the market. Furthermore, unsystematic risk can be mitigated through diversification, but systematic risk cannot be eliminated this way.

What is unsystematic or idiosyncratic risk?

Idiosyncratic risk, also known as unsystematic risk, refers to the inherent risk associated with investing in a particular asset, like a stock. This type of risk is unique to an individual investment, rather than being related to risks that impact the overall market or a diversified portfolio.

What are the types of unsystematic risk?


Common types of unsystematic risk include:

  • Business risk: Risks related to a company’s operations, management decisions, or product demand.
  • Financial risk: Risks associated with a company’s financial structure, such as debt levels or liquidity issues.
  • Operational risk: Risks from internal processes, systems failures, or human errors.
  • Legal and regulatory risk: Risks arising from changes in laws, regulations, or compliance issues.
  • Industry-specific risk: Risks unique to a particular industry, such as supply chain disruptions or shifts in consumer preferences.

What is unsystematic risk formula?

There isn’t a direct standalone formula for unsystematic risk since it’s part of the total risk in an investment. However, it is often calculated as the difference between total risk and systematic risk:

Unsystematic Risk= Total Risk−Systematic Risk

Is currency risk unsystematic?

Currency risk is generally considered a systematic risk because it affects all companies exposed to foreign exchange fluctuations and is tied to global economic factors. However, in some cases, if currency risk impacts a specific company more than others (due to its unique exposure), parts of it could be viewed as unsystematic.

What is an example of unsystematic risk?

An example of unsystematic risk is a factory fire that disrupts a single company’s operations but does not affect the broader market. Other examples include a product recall, management fraud, or a lawsuit against the company.

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