Idiosyncratic Factors (Unsystematic Risk)

Idiosyncratic factors are companyor industry-specific events that affect only a single firm or small group of firms, not the overall market.

Examples: product recalls, management changes, lawsuits, strikes, or innovation breakthroughs.

Represent unsystematic risk, which can be diversified away through holding a broad portfolio.

In contrast, systematic risk (e.g., interest rates, inflation, recessions) affects all firms and cannot be diversified away.

In CAPM, idiosyncratic risk is captured by the error term ($ϵ$) in the Regression:

$$R_i=\alpha +\beta R_m+ϵ$$