Systematic Risk

The risk remaining after diversifying a portfolio of stocks. This risk is referred to as market risk. Total risk is the overall variability of the returns of a financial asset. Total risk of a financial asset such as a stock is made up of two types of risks—systematic and unsystematic risk. Unsystematic or diversifiable risks can be diversified away by having a large, well-diversified portfolio of stocks. Systematic risk is the risk that remains, and it must be borne by investors for being in the stock market. This risk arises from external forces such as the economy and government policies. Systematic risk can be quantified by using a statistical technique to develop a risk-measuring barometer called beta. The beta of a stock measures the sensitivity of the stock to the market. Investors are compensated for taking on systematic risk but not unsystematic risk, which can be diversified away. For more information, see Ehrhardt and Brigham (2003).