Systematic risk is affected by macro-economic factors such as variability of inflation, change in interest rate, and change in money supply. Unsystematic risk is affected by company-specific factors such as wrong strategic planning.
The difference between systematic risk and unsystematic risk are:
- Definition: Systematic risk is that portion of the security risk which cannot be diversifiable from portfolio combination and which usually arises from the movement of the market or economic forces.
- Nature: Uncontrollable.
- Affects: a Large number of securities in the market.
- Measurement: Systematic risk is measured by beta.
- Diversification: Cannot be diversified.
- Factors: External factors
- Types: Interest risk, market risk, and purchasing power risk.
- Return expectation: As it cannot be diversified investors require a premium or return for this risk.
- Protection: Asset allocation.
- Definition: Unsystematic risk is that portion of the security risk which can be diversifiable through portfolio formation.
- Nature: Controllable.
- Affects: Only a particular company.
- Measurement: Unsystematic risk is measured by error term epsilon.
- Diversification: Can be diversified.
- Factors: Internal factors.
- Types: Business risk and financial risk.
- Return expectation: Investors don’t except return against unsystematic risk because it can be diversified away.
- Protection: Portfolio diversification