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Unavoidable Risk: Do you know what systemic risk is?
In finance and economics, systemic risk refers to those events that affect overall outcomes, such as market returns, overall economic resource holdings, or total income. Such risks cannot be diversified in many cases because they result from government policies, international economic forces, or natural events. Whether it is an earthquake, epidemic or major weather disaster, it can have a profound impact on the entire market, so this type of risk is called "inevitable risk" to some extent.
Systematic risk, also often called overall risk, means that it affects all market participants, regardless of how an individual's investment portfolio is designed.
In contrast, specific risk refers to the risk that only a specific agent or industry faces, and this risk is usually unrelated to the general trend of the market. Through diversification, investors can reduce the impact of specific risks, but systemic risk cannot be limited in this way because all market participants share this risk.
All market participants are exposed to systemic risk, which cannot be reduced through diversification.
In financial investment, systemic risk plays an important role in asset allocation. Risks that cannot be eliminated through diversification can earn returns that exceed the risk-free rate. This means that over the long term, the returns of a well-diversified portfolio should be commensurate with the systemic risk it assumes. For each investor, their expected returns should be consistent with their tolerance for systemic risk and asset selection.
Under the influence of systemic risk, the correlation between assets and market returns becomes more important.
For example, in a simple scenario, assume an investor purchases a variety of stocks from multiple global industries. Although this investor has eliminated specific risks, he is still exposed to systemic risks. To further reduce risk, he must choose risky assets with lower returns, such as U.S. Treasury bonds. In contrast, if another investor puts all his money into a sector and the returns in that sector are generally uncorrelated with broad market outcomes, he may be less sensitive to systemic risk but highly vulnerable due to a lack of diversification. to specific risks.
In economics, systemic risk comes from many sources. Whether it is fiscal, monetary or regulatory policies, these risks may arise. In addition, natural disasters or weather phenomena can also trigger systemic risks. For small economies, international conditions such as terms of trade shocks can also be a source of systemic risk.
Systemic risks have a huge potential impact on economic growth.
For example, in the case of credit rationing, systemic risk may lead to bank failure and hinder the accumulation of capital. When banks face systemic risks that threaten to increase profits, they may raise quality and quantity standards to reduce monitoring costs. However, such an approach may reduce the diversity of the bank's investment portfolio and increase concentration risks. As a result, both capital accumulation and overall productivity may decline.
For some scholars, it is important to combine linear and nonlinear models to analyze the characteristics of systemic risks. Since the results of most models heavily depend on the nature of risk, when modeling the economy, the model output needs to consider stimuli from internal and external factors. The interconnection of systemic and specific risks makes it challenging for economists to predict where markets will go.
In many scenarios, systemic risk can affect the entire economy, not just a single industry or company.
Economic models involving systemic risk often consider multiple factors and explore how their impact on the economy can be mitigated. This has led to initiatives for international cooperation and the creation of global hedging markets to reduce systemic risks at the country level. This is not only a challenge to the capital market, but also requires policy coordination and resource integration among countries.
So, when faced with inevitable risks, how should we respond and adapt to protect our assets and economic future?
