In this view, “risk” would be best applied to a highly controlled environment, like a pure game of chance in a casino, and “uncertainty” would apply to nearly everything else.Įven so, Knight’s distinction about risk and uncertainty may still help us analyze the recent behavior of, say, financial firms and other investors. In the real business world, this objection goes, all events are so complex that forecasting is always a matter of grappling with “true uncertainty,” not risk past data used to forecast risk may not reflect current conditions, anyway. Some economists have argued that this distinction is overblown. But the economic outlook for airlines 30 years from now involves so many unknown factors as to be incalculable. A known risk is “easily converted into an effective certainty,” while “true uncertainty,” as Knight called it, is “not susceptible to measurement.” An airline might forecast that the risk of an accident involving one of its planes is exactly one per 20 million takeoffs. “There is a fundamental distinction between the reward for taking a known risk and that for assuming a risk whose value itself is not known,” Knight wrote. Uncertainty, on the other hand, applies to situations where we cannot know all the information we need in order to set accurate odds in the first place. ![]() Therefore, according to Knight, risk applies to situations where we do not know the outcome of a given situation, but can accurately measure the odds. ![]() As Knight saw it, an ever-changing world brings new opportunities for businesses to make profits, but also means we have imperfect knowledge of future events. For this reason, the crisis has cast new attention on an idea about risk from decades past: “Knightian uncertainty.”įrank Knight was an idiosyncratic economist who formalized a distinction between risk and uncertainty in his 1921 book, Risk, Uncertainty, and Profit. The global economic crisis of the last two years has stemmed, in part, from the inability of financial institutions to effectively judge the riskiness of their investments.
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