What does 'market risk' refer to in the context of investments?

Market risk specifically refers to the potential for an investor to experience losses due to a decrease in the overall market value of investments or specific asset classes. This type of risk arises from factors that could impact the overall financial market, such as economic downturns, geopolitical events, or changes in investor sentiment. It is important to distinguish market risk from other types of risks; for instance, interest rate risk pertains primarily to the fluctuations in interest rates that affect cash flow and fixed-income investments, while default risk concerns the possibility that a borrower may fail to meet obligations. Market risk encompasses a broader spectrum of potential impacts on investment value, making it a crucial consideration for investors in asset allocation and portfolio management. Understanding market risk helps investors prepare for periods of volatility and make informed decisions about risk tolerance and investment strategy.