Systemic risk is the possibility that an event at the company level could trigger severe instability or complete collapse of an entire industry or economy. Systemic risk was one of the main contributing factors to the financial crisis of 2008.
If you think about it like a domino effect, if there are a number of dominoes that are near each other, and one of them falls, it’s likely to knock over another one, which knocks over another one, which knocks over another one and so on. Large institutions that make up a large portion of the economy are highly interconnected with other companies or a single source, which creates the systemic risk.
A classic example of a company that was a systemic risk was Lehman Brothers, which was tightly integrated to the US economy. So when it collapsed, it created problems throughout the financial system and the economy of the US, which also had a knock on to other countries around the world. The truth about systemic risk is that there really is no way of mitigating it completely, other than diversifying your portfolio across many industries, geographies and investment types.
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