Knightian uncertainty
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In
Knightian uncertainty is named after University of Chicago economist Frank Knight (1885–1972), who distinguished risk and uncertainty in his 1921 work Risk, Uncertainty, and Profit:[1]
- "Uncertainty must be taken in a sense radically distinct from the familiar notion of Risk, from which it has never been properly separated.... The essential fact is that 'risk' means in some cases a quantity susceptible of measurement, while at other times it is something distinctly not of this character; and there are far-reaching and crucial differences in the bearings of the phenomena depending on which of the two is really present and operating.... It will appear that a measurable uncertainty, or 'risk' proper, as we shall use the term, is so far different from an unmeasurable one that it is not in effect an uncertainty at all."
In this matter Knight's own views were widely shared by key economists[2] in the 1920s and 1930s who played a key role distinguishing the effects of risk from uncertainty. They were particularly concerned with the different impact on human behavior as economic agents. Entrepreneurs invest for quantifiable risk and return; savers may mistrust potential future inflation.
Whilst Frank Knight's seminal book[1] elaborated the problem, his focus was on how uncertainty generates imperfect market structures and explains actual profits. Work on estimating and mitigating uncertainty was continued by G. L. S. Shackle who later followed up with Potential Surprise Theory.[3][4] However, the concept is largely informal and there is no single best formal system of probability and belief to represent Knightian uncertainty. Economists and management scientists continue to look at practical methodologies for decision under different types of uncertainty.
Related concepts
Common cause and special cause
The difference between predictable variation and unpredictable variation is one of the fundamental issues in the
Ellsberg paradox
The
Black swan events
A black swan event, as analyzed by Nassim Nicholas Taleb, is an important and inherently unpredictable event that, once occurred, is rationalized with the benefit of hindsight. Another position of the black swan theory is that appropriate preparation for these events is frequently hindered by the pretense of knowledge of all the risks; in other words, Knightian uncertainty is presumed to not exist in day-to-day affairs, often with disastrous consequences. Taleb asserts that Knightian risk does not exist in the real world, and instead finds gradations of computable risk.[5]
See also
- Information asymmetry
- Perfect information
- Emanuel Derman § Models.Behaving.Badly
- There are known knowns
- Uninformative prior
References
- ^ Houghton Mifflin Company
- ISBN 978-3-319-55351-1.
- ISBN 0-19-828157-9.
- ISBN 978-0-415-86230-1.
- ^ Taleb, Nassim Nicholas (2015). Silent Risk (PDF).