Firm-specific risk

Definition

Firm-specific risk is the risk associated with an individual company or asset, independent of market-wide factors. It can be mitigated through diversification in a portfolio.

5 Must Know Facts For Your Next Test

1. Firm-specific risk is also known as unsystematic risk.
2. It arises from factors such as management decisions, product recalls, or regulatory impacts specific to a single firm.
3. Unlike market risk, firm-specific risk can be reduced by holding a diversified portfolio.
4. Examples include a company's earnings report, management changes, or litigation issues.
5. Firm-specific risk is not compensated by higher returns because it can be eliminated through diversification.

Review Questions

• What is another term for firm-specific risk?
• How can investors reduce firm-specific risk in their portfolios?
• Give two examples of events that could contribute to firm-specific risk.

Related terms

Market Risk: The potential for an investor to experience losses due to overall market factors which cannot be mitigated through diversification.

Diversification: A strategy that involves spreading investments across various assets to reduce exposure to any single asset's risks.

Systematic Risk: The inherent risk affecting the entire market or a particular segment, also known as market risk or non-diversifiable risk.