Which of the following best describes systemic risk?

Systemic risk refers to the potential for a major disruption in the financial system that can lead to widespread difficulties across the entire market or economy. It encompasses the cascading effects that occur when one entity's failure can trigger failures in other interconnected entities, ultimately impacting the overall financial landscape. This type of risk is not just about individual companies or sectors but considers the health of the entire economic system.

For instance, when a major bank or financial institution faces insolvency due to exposure to toxic assets, it can lead to a loss of confidence in the financial system, resulting in credit crunches, increased volatility in markets, and even economic recession. Such contagion effects illustrate how vulnerabilities can spread across interconnected entities in the financial system, showcasing the essence of systemic risk.

In contrast, other options focus on risks that are more localized or specific to certain investments or diversification strategies, which do not address the widespread implications of systemic risk on an entire financial infrastructure or economy.