Explain diversifiable risk and non-diversifiable risk in financial markets?

Non-diversifiable risk can be referred to a risk which is common to a whole class

of assets or liabilities. The investment value might decline over a specific period of time
only due to economic changes or other events which affect large sections of the market.
However, diversification and asset allocation can provide protection against nondiversifiable risk as different sections of the market have a tendency to underperform at
different times. Non-diversifiable risk can also be referred as market risk or systematic
risk.
Putting it simple, risk of an investment asset (real estate, bond, stock/share, etc.)
which cannot be mitigated or eliminated by adding that asset to a diversified investment
portfolio can be delineated as non-diversifiable risks. Moreover, this is the risk you are
exposed to in an individual investment. This risk type is involved in almost every
investment, i.e. uncertainty of market moving up or down and the particular movement of
the investment. Being unavoidable and non-compensating for exposure to such risks,
non-diversifiable risk can be taken as the significant section of an assets risk attributable
to market factors affecting all firms. The main reasons for this risk type include inflation,
war, political events, and international incidents. Moreover, it cannot be purged through
diversification.
Non-diversifiable risk is an outcome of factors influencing the complete market
like changes in investment policy, foreign investment policy, alterations in taxation
clauses, altering of socio-economic parameters, global security threats and measures, etc.
the non-diversifiable risk is not under the investors control and is also difficult to be
mitigated to a large extent. However, non-diversifiable risks are identified through the
analysis and estimation of the statistical relationships between the different asset
portfolios of the company through different techniques, including principal components

analysis. There is no specific method that can be used to handle the non-diversifiable risk.
This is due to their impact which is reflected on the entire market.
Diversifiable risk is the risk of price change due to the unique circumstances of a
specific security, as opposed to the overall market. This risk can be virtually eliminated
from a portfolio through diversification, also called unsystematic risk. It is unlikely that
events such as the ones listed above would happen in every firm at the same time.
Therefore, by diversifying, one can reduce their risk. There is no reward for taking on
unneeded unsystematic risk.
On the other hand, some events can affect all firms at the same time. Events such
as inflation, war, and fluctuating interest rates influence the entire economy, not just a
specific firm or industry. Diversification cannot eliminate the risk of facing these events.
Therefore, it is considered un-diversifiable risk. This type of risk accounts for most of the
risk in a well-diversified portfolio. It is called systematic risk or market risk. However,
the expected returns on their investments can reward investors for enduring systematic
risks. Investors are induced to take risks for potentially higher returns. However, not all
risks offer such potential rewards. The wise investor identifies these risks and eliminates
them from his or her portfolio through diversification.
Therefore, different choices are made by investors regarding whether to agree to
or not different investment options depending on the risk type involved in such
investments. In case of a non-diversifiable risk, including inflation and wars, investors
choose to invest in portfolios, like real estate, which involve lesser risk.