What is Idiosyncratic Risk?
Also called unsystematic risk, idiosyncratic risk isassociated with a company's particular circumstances.
How Does Idiosyncratic Risk Work?
For example, price changes can occur in Company XYZ inflation, interest rates, changes in tax policy or trade relations. These things may affect the stock price, but then again those affect all company stock prices. That is, they are systematic.
Investors in Company XYZ stock those systematic risks simply by in in general. But they also take on idiosyncratic risk with Company XYZ. Those risks might be things such as the company's ability to price its products profitably, the company's management expertise, the company's supply chain strength and the company's marketing prowess. Those things are within Company XYZ's control and thus they are risks specific to Company XYZ.
Why Does Idiosyncratic Risk Matter?
Investors often don’t appreciate that some of the asset allocation; idiosyncratic risk influences picking.
What is most important about this notion, however, is that diversification can mitigate idiosyncratic risk. That is, an investor can buy that don't "move together" so that some rise when others fall. Diversification generally cannot mitigate .