Which of the following best describes systemic risk?

Systemic risk is fundamentally about the potential for significant disruptions in the financial system as a whole, stemming from the failure of a single entity or group of entities, particularly large institutions. In this context, the failure of a large investment bank can trigger a chain reaction that affects other financial institutions, markets, and ultimately the entire economy. This type of risk is interconnected with factors that can lead to widespread instability, as opposed to risks tied to individual assets or industries.

For example, the 2008 financial crisis was significantly influenced by the collapse of major financial institutions, which had cascading effects throughout the banking system and beyond. This illustrates how systemic risk encapsulates broader economic vulnerabilities and not merely localized concerns about specific assets or sectors.

In contrast, risks specific to individual investments, market volatility, or particular industries represent localized or idiosyncratic risks, which do not capture the broader implications that define systemic risk. Thus, the essence of systemic risk lies in its capacity to induce a widespread failure that extends far beyond a single entity, making the described scenario of a large investment bank's failure accurately representative of systemic risk.