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Systematic risk is the market risk or the risk that cannot be diversified away, as opposed to "idiosyncratic risk", which is specific to individual stocks. It refers to the the movements of the whole economy. Even if we have a perfectly diversified portfolio there is some risk that we cannot avoid and this is the systematic risk. However, the systematic risk is not the same for all securities or portfolios. Different companies respond differently to a recession or a booming economy. (Think of the automobile industry compared to the food industry in case of a recession. Both of them will be affected negatively but food industry not as much as automobile industry.)

In insurance it is difficult to obtain financial protection against "systemic risks" because of the inability of any counter-party to accept the risk. For example it is difficult to obtain insurance for life or property in the event of nuclear war. The essence of systematic risk is therefore the correlation of losses. "Systemic Risk" adds the important problem, that it is much more difficult to evaluate than "systematic risk". For example, while econometric estimates and expectation proxies in business cycle research led to a considerable improvement in forecasting recessions, data on "Systemic Risk" is often hard to obtain, since interdependencies and counter party risk on financial markets play a crucial role. If one bank goes bankrupt and sells all its assets, the drop in asset prices may induce liquidity problems of other banks, leading to a general banking panic.

One concern is the potential fragility of some financial markets. If the participants are trading at levels far above their capital bases, then the failure of one participant to settle trades may deprive others of liquidity, and through a domino effect expose the whole market to systemic risk.

Risks can be reduced in four main ways: Avoidance, Reduction, Retention and Transfer. Systematic risk is a risk of security that cannot be reduced through diversification. Also sometimes called market risk or un-diversifiable risk. Participants in the market, like hedge funds, can themselves be the source of an increase in systemic risk^[1] and transfer of risk to them may, paradoxically, increase the exposure to systemic risk.

One of the main reasons for regulation in the marketplace is to reduce systemic risk.

1. ^ Systemic risk and hedge funds

• Modern portfolio theory
• Capital asset pricing model
• Risk modeling