Idiosyncratic risk analysis
Chapter 21 primary question: Fully develop the AD/AS model with inflation and output as its axis labels in both the short run and long run. Be sure to include all of the elements that go into its development.
Chapter 22 primary question: Describe the Great Moderation, when and how it came about and why it ended as badly as it did.
Chapter 23 primary question: Summarize all of the channels by which the monetary policy transmission mechanism can work.
example of a really good answer:
Distinguish between idiosyncratic and systemic risk.
Idiosyncratic risk is the risk that results from owning a specific security in the form of a stock, bond, CD, etc. It is the risk you think of when you think about losing money investing in a specific thing. For example, if you bought a share of AMZN, and then earnings came out and they were disappointing and the stock price falls resulting in you losing money, you just suffered the consequences of idiosyncratic risk. You can diversify against idiosyncratic risk by purchasing many different securities so that when one does poorly, it doesn’t affect you as much because the others are likely to not be suffering the same problems.
Systemic risk, on the other hand, is risk that affects many securities at once. These are often geopolitical events that result in the market as a whole being affected. For example, a highly infectious virus might originate somewhere in the world and start to spread aggressively causing economic slowdowns/lockdowns that in turn affect the performance of many securities at once. These sorts of things are generally out of the hands of individual investors, and cannot be so easily diversified against.
Sample Solution
Idiosyncratic risk analysis
The Great Moderation is the name given to the period of decreased macroeconomic volatility experienced in the United States in the 1980s. during this period, the standard deviation of quarterly real gross domestic product (GDP) declined by half and the standard deviation of inflation declined by two-thirds according to figures reported by U.S. Federal Reserve Chair Ben Bernanke. The Great Moderation can be summed up as a multi-decade period of low inflation. The Great Moderation was merely interrupted by the Great Recession and the recent financial crisis, due to “bad shock” as opposed to long-lasting structural changes in the economy or “bad policy” (Clark, 2009). This is also consistent with the findings of Stock and Watson (2012).
