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Introduction
The relationship between total risk, no-diversifiable risk, and diversifiable risk are in the context of the level of diversifiable in the investment portfolio, which is critical in identifying the type of risk to diversify as economic investment environment dynamically changes. In this case, diversifiable risk is the only relevant risk because of its specificity
Total risk
An aggregate of all the total factors associated with making an investment decision is referred to as total risk. Each of the factors associated with making decisions that have the potential to adversely impacts on business investment making are classified into no-diversifiable and diversifiable risks, making total risks.
In this case, total risk needs to be assessed before making an investment to avoid the potential for making loses, which are outcomes that significantly vary from the expected value and financial returns. In this case, the link between total risks and other risks is separated from each other by the Capital Asset Pricing Model (CAPM), in theory.
Here, total risk in finance can be market dependent with attributes where the different market drivers determine the degree of returns for a risk to impact investments. While total risk underlies the perspective of risk in its varied forms, one of the forms of risk is no-diversifiable risk.
No-diversified risk
No-diversifiable risk, which is also referred to as systematic risk is defined in the context of the entire class of assets and liabilities. The rationale for this type of risk is that the value of an asset depreciates with time as economic factors change with changing market conditions. That is because the risk of an investment asset cannot be mitigated, and that affects both corporate and individual investments.
The latter makes it mandatory to add the asset into a diversified investment portfolio, which is then delineated into the no-diversifiable risk. In context, market risks, purchasing power risks, and interest rate risks underlie the driver factors no-diversifiable risk. Another element of risk is diversifiable risk.
Diversified risk
On the other hand, diversifiable risk is risk defined in the context of unsystematic risk which can be removed through diversification since it belongs to part of an asset’s risk. In this case, diversifiable risk can be narrowed into specific asset-related events in a firm that can be in the form of regulatory actions, lawsuits, loss of a key account, and strikes.
The underlying cause of diversifiable risk is industrial specific events such as pricing, marketing, research and development, and labor unions. Here, diversifiable risk is in the context of business risks, default risks, and financial risks. The key characteristic of diversifiable risk is that it has limited impact on diversified portfolio. Comparatively, diversifiable risk is the only relevant risk.
Diversified risk as only relevant risk
That diversifiable risk is the only relevant risk is correct. That is because diversifiable risk is limited to a specific asset and can be accurately identified in relation to its impact on an asset. That is in addition to the fact that such a risk allows for diversification depending on the universe of investment and can be controlled by hedging.
Conclusion
There are strong relationship and differences between the total risk, no-identifiable risk, and indefinable risk, with each defines in the context of risk, but varying in the diversification or no-diversification portfolio.
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