20. Uncertainty And Risk
The presence of uncertainty means that more than one outcome is
possible. Tossing a com presents a situation of uncertainty since two
outcomes are possible. If no information is available on the nature of the
coin, we then cannot make any ex-ante estimation of the probability of
receiving one outcome or another. Economists call this situation
unmeasurable uncertainty. In contrast, measurable risk is what we have
when probability estimates can be attached to a range of possible outcomes.
In tossing a fair coin, we know that there is a 50 percent chance of getting
heads or tails.
It seems that we are not living in a very certain world with more
economic boom and burst, more natural catastrophe, and more man-made
threats ranging from the environment to terrorism. Take an example of the
on-going bird-flu outbreak in Asia which is causing havoc to not only
farmers but.also restaurants and tourism. This is pure uncertainty since no
historical data are available to estimate the probability that the disease
occurs. This makes the task of insuring against and managing this type of
uncertainty extremely difficult.
Unsurprisingly, we therefore prefer a situation in which we can obtain
probability estimates based on accumulated historical data so that risk can
be quantified and managed.
The bright side is that with increased use of information technology and
sophisticated markets, this task can now be done with greater ease.
Nevertheless, research has shown that misjudging risks is in human nature.
Over-optimism is a common factor leading to mistakes. People have high
hopes for the future. In a real-estate bubble, investors tend to discount the
risk of market collapse and believe in ever-rising prices. Likewise, in
financial distress, panic sets in causing investors to make irrational
decisions to unload their investments as soon as possible.
