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4 Types of Market Risk
John Spacey, updated on March 20, 2021
Market risk is the potential for price changes in a market to result in investment losses. It is often measured with a concept known as volatility that attempts to predict the potential for price fluctuations of an investment based on its historical price movements. There are several major types of market risk:
1. Equity RiskThe risk associated with stock prices. In many cases, stocks have higher associated risks than other investment classes such as government bonds. Some types of equities such as small cap stocks traded on emerging markets can be extremely volatile.
2. Interest Rate RiskThe risk of unpredictable interest rate changes. The prices of most assets are sensitive to changes in interest rates. For example, the price of fixed interest rate bonds typically declines as interest rates rise.
3. Exchange Rate RiskExchange rates can change rapidly as they are affected by a wide range of political and economic conditions. Many businesses have exposure to interest rates both in terms of costs and revenue sources. As a result, changes in exchange rates can lead to volatility in a company's margins and profitability. Exchange rates also directly impact the value of foreign assets such as property.
4. Commodity RiskThe prices of commodities such as grains or fuels can be volatile in the short term. Commodity prices can also follow long cycles meaning that prices can remain elevated or depressed for extended periods of time. As a result, commodity price volatility is a key risk to industries that directly produce commodities or that use them as an input.
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