Systematic vs unsystematic risk

The COVID pandemic has affected almost every one. That is systematic risk. A drought will mainly affect people growing crops. That is unsystematic risk.

Some people and businesses were more affected by COVID. For instance schools in Uganda are still closed. The degree of correlation of an asset with systematic risk is usually called beta.

A high positive beta means an asset is generally very risky compared with the general economy. Businesses with high betas do well when the economy is growing and suffer when the economy collapses. We can say that the school business has a high beta especially during COVID.

A negative beta means an asset is less risky and does well when the economy is doing badly. For example some businesses thrived during the lockdown. People in food production and health services made a lot of money during lockdown. So the food business had a negative beta.

There is nothing much we can do about systematic risks since they affect everyone. On the other hand we can diversify away unsystematic risks. The farmer facing drought can diversify into animal husbandry or value addition. The school owner can also set up a farm or hospital.

An understanding of systematic and unsystematic risks can help an investor to design a resilient portfolio which optimizes her return.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s