What type of risk can typically be reduced through diversification?

Unsystematic risk, also known as specific or idiosyncratic risk, refers to the risk inherent to a particular company or industry. This type of risk can arise from factors such as management decisions, product recalls, or competitive pressures that affect a specific entity rather than the entire market.

Diversification involves spreading investments across a range of assets or sectors to mitigate the impact of any single asset's poor performance. By holding a diversified portfolio, investors can reduce unsystematic risk because the negative performance of one investment can be offset by the positive performance of others. For instance, if a particular company faces challenges leading to a decline in its stock value, investments in different sectors or companies that are performing well can help stabilize the overall portfolio value.

In contrast, systematic risk, market risk, and inflation risk cannot be reduced through diversification. Systematic risk affects the entire market and is influenced by factors like economic changes, political events, or natural disasters. Thus, while unsystematic risk can be effectively managed through diversification, the other types of risk require different strategies to address their inherent nature.