What does "systematic risk" refer to in finance?

Systematic risk refers to the risk inherent to the entire market or a specific market segment, which affects all companies and investments to some degree. This type of risk results from factors such as economic shifts, political instability, changes in interest rates, and natural disasters, which cannot be diversified away through individual asset selection.

This concept is fundamental in finance as it underscores the idea that certain risks are faced by all market participants, making them unavoidable. For instance, during an economic recession, the majority of companies may experience declines in earnings regardless of their individual performance, illustrating the nature of systematic risk.

On the other hand, risks specific to a single company or sector, which can be mitigated through diversification, do not contribute to systematic risk. Additionally, systematic risk is not limited to bond investments; it applies to all equity assets and other investment instruments. Finally, since systematic risk cannot be eliminated by holding a diversified portfolio, it remains a critical consideration in portfolio management.