Endogenous risk is a category of financial risk that arises from the interaction of market participants. It is created endogenously (as opposed to exogenous risk) due to a source of volatility that cannot be explained and attributed to specific factors. In other words, this risk is created by non-fundamental  factors. Influences or shocks that initiate from outside the financial system or a specific marketplace are exogenous risks, such as market participants’ reaction to external developments such as news events which can potentially exacerbate the impact of such development by the very reaction of a market player (e.g., when market participants go on selling, prices start to fall, triggering further selling, etc.)

For example, when a market participant is of a small size relative to the overall market, or when the active traders take diverse positions, traders’ decisions on the market dynamics would not be expected to produce any significant effect on the entire market. However, when a large sector of the market is moves together, the market dynamics may be affected by the collective move, and may result in potentially destabilizing price movement.

A prime example of an endogenous risk is the stock market crash of 1987, where concerted selling pressure had a destabilizing “feedback effect” which changed market fundamentals as a consequence.

Endogenous risk is better represented by a feedback loop where market distress would feed on itself. Unprecedented price movements result from such a feedback loop where, for example, margin calls lead to market participants unwinding leveraged trades, which in turn produce adverse price moves, and all the way towards a large scale distress, completing the loop and reinforcing further rounds towards more margin calls, etc.