Which type of risk can be mitigated through diversification?

Unsystematic risk, also known as specific or diversifiable risk, can indeed be mitigated through diversification. This type of risk is associated with individual assets or companies, such as operational failures, management decisions, or industry-specific events. By holding a diverse portfolio of investments across various sectors and asset classes, an investor can reduce the impact of any single asset's poor performance on the overall portfolio.

For example, if an investor has shares in several companies across different industries, the negative performance of one company may be offset by the stable or positive performance of another. This diversification helps to smooth out the volatile fluctuations that can occur with individual investments, resulting in a more stable, consistent return for the investor.

In contrast, systematic risk refers to market-wide risks, such as economic downturns or changes in interest rates, which cannot be eliminated through diversification. Market risk and credit risk (associated with the likelihood of a borrower defaulting) also fall under systemic influences that diversification alone cannot mitigate effectively. Thus, the ability to reduce unsystematic risk through diversification is a foundational concept in portfolio management and investment strategy.