Disentangling Risk and Uncertainty

In certain areas or on the surface, Risk and Uncertainty seems the same, and some people do believe they are one and the same. Some school of thought thinks one leads to the other. Literarily, a risk may be taken or not, while uncertainty is a circumstance that must be faced by business owners and people in the financial world. Taking a risk may result in either a gain or a loss because the probable outcomes are known, while uncertainty comes with unknown probabilities.

Risk can be described as a situation which the outcome and probabilities of occurring is known. Risk is something that can be measured based on experience.

Uncertainty, on the other hand, is the absence of certainty. Since the event itself is uncertain, the outcomes also become uncertain. Since the outcomes are uncertain, it becomes difficult to define uncertainty or measure it. Uncertainty, therefore, reflects a situation where you are not sure of the outcomes.

Communicating about risk and uncertainty may be difficult because uncertainty is multi-dimensional. The LBS Analysis of Business Problems course was able to draw the line between Risk and Uncertainty.

Risk is a measurable probability of occurrence of event while uncertainty cannot be measured. In summary, Risk = Measurability and Uncertainty = Not measurable.

Is Risk Measurable?

What makes risk measurable is information. When we say we can measure a risk associated with a decision, it is because we have information about that situation. The implication being that what we consider risky maybe different from what someone else may consider risky because of the availability of information. This is generally termed “Risk Appetite”. The ability to measure risk is a function of the amount of information one has about the situation.

Uncertainty clearly suggests that the reason why we say a situation is uncertain is that we have no information about the different variables, and therefore we say a situation is uncertain. We cannot tell what the outcome might be. A typical example is the Covid-19 pandemic.

Impact on Decision Making

Risk and Uncertainty do have an impact on the decision-making process. The impact is that Risk refers to decision-making situations under which all potential outcomes and their likelihood of occurrences are known to the decision-maker, and Uncertainty refers to situations under which either the outcomes and/or their probabilities of occurrences are unknown to the decision-maker.

Therefore, the extent of what we say is risky or uncertain is really a function of the information we have and our understanding of the situation in any reasonable detail. Information is what makes the difference. In the Games theory, it is described as perfect versus imperfect information.

Perfect information suggests a scenario where you know exactly the response that an action will produce. For example, you can see your competitors moves sequentially. Though, it is not exactly sequential because competitors try to figure out what they can do to outdo each other at the same.

Imperfect information suggests that all possibilities are being looked at, as what could possibly happen. Here, decisions cannot be made sequentially, as all possible outcomes need to be balanced when making the decision.

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