nondiversifiable

Nondiversifiable refers to the portion of an asset’s risk that cannot be eliminated through diversification. Also called systematic risk or market risk, it stems from factors that affect the entire market or large swaths of it rather than just a single company or industry. In portfolio theory, total risk comprises two components: diversifiable (idiosyncratic) risk and nondiversifiable (systematic) risk. While diversifiable risk can be reduced or nearly eliminated by holding a broad mix of assets, nondiversifiable risk remains even in a well‑constructed, diversified portfolio.

Common sources of nondiversifiable risk include macroeconomic changes, broad inflation or deflation, shifts in interest rates, geopolitical events, regulatory developments, and widespread market downturns. These factors influence many assets simultaneously, making it difficult to offset the risk through simple diversification.

Measuring nondiversifiable risk commonly involves the asset’s beta, which reflects its sensitivity to market movements. In the Capital Asset Pricing Model (CAPM), expected returns are tied to exposure to systematic risk, implying that investors are compensated for bearing nondiversifiable risk. The portion of an asset’s variance explained by market movements represents the nondiversifiable component, while the residual variance is diversifiable.

Implications for investors include accepting that some risk cannot be avoided through diversification. Management strategies focus on risk tolerance and return objectives through asset allocation, hedging, or other risk‑mitigation techniques, recognizing that systematic risk persists across markets.

See also: systematic risk, market risk, beta, CAPM, portfolio theory.