Uncertainty: a key economic factor.

What we know and we can be certain about the economic future
is that it is largely ...unknown and uncertain.
At the difference of risk, defined as a mathematical probability,
uncertainty, by definition, cannot be really measured or even known.
Historical reference cannot be trusted fully.

Uncertainty applies to many areas including economics and finance.

The temptation is high then to follow false certainties.
As the future is foggy, predictions can be tried only through
a range of tentative scenarios.


fog Unknown territory?
Learn to love
surprise surprises!
And train to build
éventail scenarios!

What is uncertainty?

We live in it!

Uncertainty applies to situations, often met in human and social life, in
which it is impossible to know beforehand
:
  • Not only all the possible / probable future events,
whether positive or negative, ordinary or decisive.
Making a variety of scenarios would help broaden the vision.
  • Even less what the surprise next event or outcome, will be.
How would we have foreseen before the discovery of
America
the irresistible irruption of tomatos and potatoes
in European
cuisine ?
How did poor cabbages survived such an onslaught ?
(probable frequency),
except for events that happen routinely.

This is what makes uncertainty differ from pure "risk":

in case of uncertainty the odds are not measurable.

Historical series, the main reference to calculate probabilities
are far from fully
reliable, at least in the current world
upheaval situation.


This fog about the future can be found
  • In fully new, jump disruptive, unprecedented situations
Such situations can happen at any moment in our ever
changing society
(and in the Universe),  a trait it shares
with any
dynamical system.
  • In rare / anomalcluster exceptional situations ("black swans"),
This means events with only few precedents, of which the
memory is blurred.

Therefore their past frequencies are unavailable or irrelevant
to use as probabilities
. We find only unadapted, or too scarce
data information.

Altogether, uncertainty is something we don't know
but are ...certain to meet!

Attitudes towards uncertainty

Hate it or love it!

People are usually more uncertainty averse than risk averse, as shown
for example by
behavioral economics research.

To take the example of sous economic players, this can have quite different
behaviors to express uncertainty averson :
  • Either they become very cautious when taking decisions.
They would be highly wary to invest in unstable assets (stocks).

That is why not only identified risks but also - in a higher degree -
uncertainty feeds
bear markets and entails high "risk premium",

To compensate the "uncertainty aversion"
normally lead to an
"uncertainty premium":

In other words, to accept to bet on a obscure future entails to
ask for very high  potential rewards
, higher ones than in
the case of "risk aversion".

In practice, in economic / financial markets this extra return is
obtained through a lower buying buysell price
.

In economics, sociology, and management politics, uncertainty
leads often to shun initiative when facing new openings
(precautionary principle, covering one's "a.s")
Which does not prevent some people to take initiative either
because they do not accept passivity, or because they build
false certainties (see below).
  • Or they invent false certainties
or at least are victims of apparent certainty (pseudo
certainty).

Those illusion illusions allow them to alleviate the pain they
feel when living in uncertainty

But is uncertainty always apparent?

Trusting or not past History?

In some cases people might not realize, and might even deny, that they
face uncertainty.

But also uncertainty might be hidden as things might seem to follow
the norm, for example when they match a classical law of probability.

This rather common smoke screen might be the result of:
  • Either some anchor mental block or magical thinking
that creates an illusion of certainty.
  • Or the fact that in many cases, uncertainty is not apparent.
In such cases, everything seems to be running smooth ...or to
be falling apart without hope.

Nothing is seen on the surface that would feed doubt about the
final outcome
in both cases.

The evolution takes place underground and/or will be triggered
by an expected shock.
 
  • Or, an excessive trust in  historical probabilist tools
and/or a wrong use of them.
This is because uncertainties are hidden, 
and/or not enough
attention is given
to evolutions, potential disruptions and rare
events.

So what to do?

Have plans, but be ready to switch or adapt.

Prepare all kind of scenarios, even extreme ones, what else?

Also be ready to change your plans.
Thus beware of resistance to change / status quo bias / mental
conservatism (see
underreaction)

For more details

See the main article on the topic: Risk and uncertainty

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M.a.j. / updated : 20 Sept. 2015
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