π What is Systemic Risk?
Systemic risk refers to the risk of collapse of an entire financial system or market, as opposed to the failure of an individual entity, group, or component of a system. It's like a domino effect β if one major institution fails, it can trigger a cascade of failures throughout the entire system.
π - π Definition: The risk of a breakdown in an entire system, rather than just one part.
π₯ - π₯ Trigger: Often triggered by a large shock or failure within the system.
βοΈ - βοΈ Impact: Can lead to widespread economic disruption.
π What is Systematic Risk?
Systematic risk, also known as market risk or non-diversifiable risk, is the risk inherent to the entire market or market segment. It affects all assets to some degree and cannot be reduced through diversification. Examples include changes in interest rates, inflation, recessions, and war.
βοΈ - βοΈ Definition: Risk inherent to the entire market or market segment.
π‘οΈ - π‘οΈ Diversification: Cannot be reduced through diversification.
πΈ - πΈ Examples: Interest rates, inflation, recessions.
π Systemic Risk vs. Systematic Risk: A Comparison
| Feature |
Systemic Risk |
Systematic Risk |
| Definition |
Risk of failure of an entire system. |
Risk inherent to the entire market. |
| Scope |
Focuses on interconnectedness and contagion. |
Affects all assets in the market. |
| Diversification |
Not directly mitigated by diversification; requires regulatory oversight. |
Cannot be reduced through diversification. |
| Examples |
Failure of a major bank, causing a financial crisis. |
Changes in interest rates, inflation, recessions. |
| Mitigation |
Increased capital requirements, stress tests for financial institutions. |
Hedging strategies, asset allocation. |
π‘ Key Takeaways
π― - π― Systemic risk is about the stability of the entire financial system, while systematic risk affects all assets in the market.
ποΈ - ποΈ Systemic risk requires regulatory solutions, while systematic risk requires individual investment strategies.
π - π Understanding both types of risk is crucial for financial stability and informed investment decisions.