"Idiosyncratic risk" refers to the possibility of a specific event or factor affecting the performance or value of an individual investment. It is related to unique characteristics or circumstances that can impact an investment differently from the broader market or other investments.
Full definition
Many investors believed they had an adequately diversified portfolio, containing a number of independent sector positions and a portfolio
of idiosyncratic risks.
The role of ETF positions is generally to
access idiosyncratic risk / return exposures and maintain a higher resilience to diverse market conditions.
And indeed research shows that
idiosyncratic risk captures the value premium and that the value premium is compensation for exposure to time varying risk.
Additionally, as recent headlines illustrate, one can not ignore
idiosyncratic risks in the different countries (for example the passing of the Thai King, or the impact of Samsung's woes on the South Korean market).
Additionally, as recent headlines illustrate, one can not
ignore idiosyncratic risks in the different countries (for example the passing of the Thai King, or the impact of Samsung's woes on the South Korean market).
Strategies that focus
on idiosyncratic risk to generate absolute returns irrespective of the market environment
«In other words, by building portfolios which seek to
minimize idiosyncratic risk exposure from specific stock, sector, factor or country bets, this fund is expected to deliver higher risk - adjusted returns.»
The authors state, «We are confident that the premium attributable to robust factors is more likely to persist than the extra performance associated
with idiosyncratic risk.»
Evidence
suggests idiosyncratic risk is associated with deteriorating earnings quality, based on the theory that the latter causes noisier earnings.
The purpose of this paper, a joint work with Vasiliki Athanasakou, is to examine whether a value premium exists over our sample period, whether systematic risk is driving the value premium,
whether idiosyncratic risk does a better job than systematic risk in explaining the value premium, and more importantly whether earnings quality contributes to a risk, mispricing or both explanations for the value premium.
You shouldn't in individual stocks, sector funds or country funds because they
contain idiosyncratic risks that can be easily diversified away and thus are what economists called uncompensated risks.
While the capital asset pricing model (CAPM) does have it flaws the general idea behind it is solid: an investor should not be compensated for
idiosyncratic risk because you can eliminate it using diversification.
However, the prediction enhancement of SDI disappears during the 2008 credit crisis, indicating that high - SDI funds have
large idiosyncratic risks exposed by crises.
If, as most believe, the higher historical returns (lower valuations) from equity (vs debt) were required compensation for assuming the risks of price volatility, and since diversification that
reduces idiosyncratic risk is now essentially free (passive ETFs), markets should no longer require all that compensation.
Bottom line: There's no free lunch on Wall Street and just about every asset class carries its own form of
idiosyncratic risk.
For a good company,
idiosyncratic risks can also turn into idiosyncratic rewards in the future, which nobody talks about.
This is a reward for taking
the idiosyncratic risk.
The other risk that needs to be considered is
idiosyncratic risk.
Idiosyncratic risk can not be planned for or modelled, but it can quickly wipe out a portfolio.
Finally,
the idiosyncratic risk of a dividend portfolio is a substantial risk that is easily mitigated through proper diversification.
BlackRock writes that the iShares MSCI World Small Cap UCITS ETF (WSML) is a way for investors to express a nuanced view within their equity allocation, allowing them to take a building block approach to broad exposure but with a lower level of
idiosyncratic risk than single stock investments.
Synonyms for diversifiable risk are
idiosyncratic risk, unsystematic risk, and security - specific risk.
This analysis reveals that the integrating strategy's
idiosyncratic risk (4.81 %) is more than 2.5 times that of the mixing strategy (1.91 %).
Juice up returns (see # 1) and spread
the idiosyncratic risk over more properties (see # 3)!
If I can spread around
the idiosyncratic risk of vacancies, major repairs, mold problems, hurricanes, earthquakes, lawsuits, etc. over a larger number of properties and over a wider geographic area, I'm all for it!
Second, the authors decompose the strategies» active risk into factor risk and
idiosyncratic risk.
The idiosyncratic risk here is huge because the portfolios are so small.
Other names used to describe unsystematic risk are specific risk, diversifiable risk,
idiosyncratic risk, and residual risk.
The resulting fall in earnings quality may contribute to a rise in
idiosyncratic risk and therefore to the value premium.
For a good company,
idiosyncratic risks can also turn into idiosyncratic rewards in the future, which nobody talks about.
Second, deteriorating earnings quality is associated with a sharp rise in analyst uncertainty (and
idiosyncratic risk) for value stocks and a rise in forward returns going from good to poor earnings quality value stocks.
This is a reward for taking
the idiosyncratic risk.
Despite this, no paper has investigated the sources of
the idiosyncratic risk as they relate to the value premium.
Hedge funds, Mutual funds, Performance evaluation, Bayesian, Appraisal ratio, Flow - performance sensitivity, Idiosyncratic risk
The idiosyncratic risk is the one that investors could diversify by holding different assets in their portfolios.
Crypto rich kids made their fortune on the rapid growth of cryptocurrency markets — which are problematic due to
their idiosyncratic risks.
When you are invested in more than one cryptocurrency asset,
the idiosyncratic risk in your portfolio decreases.