Question

How do you think ?

Diversifiable and non-diversifiable risk must be defined before examples may be given. These terms are also understood as unsystematic and systematic risk. Unsystematic risk is a hazard that is inherent within a singular industry instead of the entire market. This risk may be alleviated through the diversification of a portfolio. Alexeev and Tapon’s article discuss the use of diversification to reduce unsystematic risk. They use an example of policy that directly affected the automotive industry. Having a diversified portfolio of other sectors would greatly reduce ones risk compared to a portfolio that consisted of solely automotive common stocks. Systematic risk is a danger that is inherent within the market as a whole. An action or event that could possibly affect the entire market and is not curable with diversification. There are a multitude of examples for systematic risk, such as the 2008 financial crisis or even the recent dip due to Covid-19. However the article, “The Effects of Rate Regulation on Mean Returns and Non-Diversifiable Risk: The Case of Cable Television.” The authors describe how the 1992 Cable Act created uncertainty and increased stock betas in sectors across the board. This risk is unavoidable with stock diversification and is a prime example of systematic risk.

Answer 1

We agree with the interpretation that diversifiable risk or better known as unsystematic risk is a risk pertaining to a particular industry and can be easily reduced by diversifaction. Systemtic risk is represented by levered beta which includes risk from market as well as on account of industry/ compant related factors.

On other other hand undiversifiable risk or better known as systematic risk is the additional risk which is present in the market as a whole and thus it can be said as inherent risk on investing in stock market. Systemtic risk is represented by unlevered beta which discount total risk from industry/ compant related factors.

However there might be instances wherein any regulation which is directed to a certain industry might effect the market as a whole. Those instances are very limited and should not be treated as normal fundamental for investing. The reaction of other sectors on account of regulation in one sector is primarily based on expectations of the investors that a similar regulation might be imposed on other industries as well and thus the market reacts to it.