ECON 2000 Lecture Notes - Lecture 99: Idiosyncrasy, Systematic Risk, Financial System
14 May 2018
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ECON 2000
Lecture 99
Sharing risk
- One function of financial system is to allocate risk
- Risk averse – dislike of uncertainty
- Equity finance provides way for entrepreneurs and savers to share
the risks and returns associated the entrepreneur’s investment ideas
- Financial system allows savers to reduce risk by spreading their
wealth across many diff. businesses
- Reducing risk by holding many imperfectly correlated assets called
diversification
o Various financial institutions (e.g. mutual funds) facilitate
diversification
- Mutual funds are financial intermediaries that sell shares to savers
and use their funds to buy diversified pools of assets
- Systematic risk – macroeconomic events that affect many
businesses at same time
- Recessions reduce demand for most products and profitability of
businesses
- Diversification cannot reduce this kind of risk but can largely eliminate
risks associated with individual businesses called idiosyncratic risk
Dealing with asymmetric information
- Asymmetric information – describe a situation in which one party to
an economic transaction has more info abt the transaction than the
other
find more resources at oneclass.com
find more resources at oneclass.com
Document Summary
One function of financial system is to allocate risk. Equity finance provides way for entrepreneurs and savers to share the risks and returns associated the entrepreneur"s investment ideas. Financial system allows savers to reduce risk by spreading their wealth across many diff. businesses. Reducing risk by holding many imperfectly correlated assets called diversification: various financial institutions (e. g. mutual funds) facilitate diversification. Mutual funds are financial intermediaries that sell shares to savers and use their funds to buy diversified pools of assets. Systematic risk macroeconomic events that affect many businesses at same time. Recessions reduce demand for most products and profitability of businesses. Diversification cannot reduce this kind of risk but can largely eliminate risks associated with individual businesses called idiosyncratic risk. Asymmetric information describe a situation in which one party to an economic transaction has more info abt the transaction than the other. Financial institution developed various institutions that mitigate the effects of adverse selection and moral hazard.
