Idiosyncratic Risk

Idiosyncratic risk refers to the risk that is unique to a particular Asset or a small group of Assets. It is the portion of an Asset’s total risk that is not correlated with the overall market risk. This type of risk can arise from company-specific factors, such as management decisions, financial performance, or changes in consumer demand.

For instance, if a tech company faces a lawsuit that affects its Stock price, this situation is an example of idiosyncratic risk. It does not impact the entire tech industry or the broader market, but it significantly affects that specific company’s Stock performance.

Another example can be seen in the case of a pharmaceutical company that invests heavily in developing a new drug. If clinical trials fail, the company’s Stock may plummet due to this specific event, representing idiosyncratic risk.

In contrast, market risk, also known as systematic risk, affects all investments in the market and is tied to broader economic factors, such as Interest Rates or inflation.