Uncertainty

related topics
{rate, high, increase}
{math, energy, light}
{theory, work, human}
{math, number, function}
{island, water, area}
{company, market, business}
{style, bgcolor, rowspan}
{ship, engine, design}

Uncertainty is a term used in subtly different ways in a number of fields, including physics, philosophy, statistics, economics, finance, insurance, psychology, sociology, engineering, and information science. It applies to predictions of future events, to physical measurements already made, or to the unknown.

Contents

Concepts

In his seminal work Risk, Uncertainty, and Profit[1] University of Chicago economist Frank Knight (1921) established the important distinction between risk and uncertainty:

Although the terms are used in various ways among the general public, many specialists in decision theory, statistics and other quantitative fields have defined uncertainty and risk more specifically. Doug Hubbard defines uncertainty and risk as:[2]

There are other taxonomies of uncertainties and decisions that include a broader sense of uncertainty and how it should be approached from an ethics perspective:[3]

There are some things that you know to be true, and others that you know to be false; yet, despite this extensive knowledge that you have, there remain many things whose truth or falsity is not known to you. We say that you are uncertain about them. You are uncertain, to varying degrees, about everything in the future; much of the past is hidden from you; and there is a lot of the present about which you do not have full information. Uncertainty is everywhere and you cannot escape from it.

For example, if you do not know whether it will rain tomorrow, then you have a state of uncertainty. If you apply probabilities to the possible outcomes using weather forecasts or even just a calibrated probability assessment, you have quantified the uncertainty. Suppose you quantify your uncertainty as a 90% chance of sunshine. If you are planning a major, costly, outdoor event for tomorrow then you have risk since there is a 10% chance of rain and rain would be undesirable. Furthermore, if this is a business event and you would lose $100,000 if it rains, then you have quantified the risk (a 10% chance of losing $100,000). These situations can be made even more realistic by quantifying light rain vs. heavy rain, the cost of delays vs. outright cancellation, etc.

Some may represent the risk in this example as the "expected opportunity loss" (EOL) or the chance of the loss multiplied by the amount of the loss (10% × $100,000 = $10,000). That is useful if the organizer of the event is "risk neutral," which most people are not. Most would be willing to pay a premium to avoid the loss. An insurance company, for example, would compute an EOL as a minimum for any insurance coverage, then add on to that other operating costs and profit. Since many people are willing to buy insurance for many reasons, then clearly the EOL alone is not the perceived value of avoiding the risk.

Full article ▸

related documents
Econometrics
Gross domestic product
Tax Freedom Day
Income tax
Simpson's paradox
Kaldor-Hicks efficiency
Income
Percentage
Meta-analysis
Pareto efficiency
Measures of national income and output
Value at risk
Tax Reform Act of 1986
Analysis of variance
Gary Becker
Infant mortality
Limits to Growth
Sunk costs
Saving
Developed country
Demographics of the United States
Net present value
Norwegian krone
IS/LM model
Prevalence
Chi-square distribution
Population control
Ratio
Growth accounting
Kardashev scale