Risk and Uncertainty
Risk vs Uncertainty? First of all, risk and uncertainty are two different things.
Human nature hates ambiguity
The Ellsberg paradox shows that people are ambiguity averse. When taking risks, they prefer to base their decisions on known probabilities rather than unknown probabilities. This paradox of human nature, or intolerance of ambiguity, is an empirical finding that suggests we tend to choose known rather than unknown probabilities.
The difference between risk and uncertainty
What we want to talk about is the difference between risk and uncertainty (or ambiguity). Risk refers to a known probability. Risk is the possibility of loss and carries the connotation of probability (that is, numbers); as long as there are numbers, it can be measured. You can use it as a basis for assessing risk.
Risk is predictable, but uncertainty is not
But in the face of uncertainty, this is not possible.
Risk can be estimated, but uncertainty cannot. Risk science (statistics) is three to four hundred years old, and there are many professors specializing in this issue, but there is no textbook discussing uncertainty. That’s why we try to classify ambiguity as risk, even though the two are actually very different.
Two Examples
Economics is a field that cannot be measured with numbers because it is a social science that involves too many unknowns. Things that cannot be measured with numbers or probabilities are typical areas of ambiguity and unpredictability.
But life insurance is another counterexample. People in the insurance industry know that the core knowledge of this industry is the human life span that has been counted for hundreds of years (human life span is a known range of numbers, for example: it is impossible for someone to live to be 10,000 years old, and it has been developed The average life expectancy of most people in the country is about 70 to 90 years old. Actuaries can accurately calculate the remaining life expectancy of the insured person based on the insured person’s race, gender, age, and occupation. By knowing the remaining life of the insured, the premium can be calculated to maintain the profit of the insurance company.
People don’t like uncertainty
We naturally don’t like facing the unknown. Why do humans feel uneasy? Because most people’s anxiety comes from the fear caused by the unknown. In order to eliminate anxiety, human nature will seek answers, hoping to eliminate the unknown, thereby eliminating uncertainty and alleviating inner fear.
Whether it is religion, astrology, divination, fortune-telling, or witchcraft; this is the basis of their existence. This also explains why investors know rationally that the stock market predictions of so-called Internet celebrities and financial experts will never come true (in fact, these people themselves know that they are talking nonsense), but most people still make predictions at fixed times. People tune into their fixed channels and watch their nonsense because they are seeking psychological comfort and trying to eliminate the uncertainty for themselves.
Buffett’s view
Buffett likes “buying uncertainty.” Buffett said: “Calculations of intrinsic value, though all-important, are necessarily imprecise and often seriously wrong. The more uncertain the future of a business, the more possibility there is that the calculation will be wildly off-base.” In this case, of course, the spread will be larger and the profit will be more substantial. If the mathematical calculations required to evaluate equities are not difficult, Buffet still said that experienced and intelligent analysts can “easily go wrong in estimating future ‘coupons.’”
Benjamin Graham:”Mathematics is ordinarily considered as producing precise and dependable results; but in the stock market the more elaborate and abstruse the mathematics the more uncertain and speculative are the conclusions we draw therefrom.”
Buffett likes “buying uncertainty.” Buffett said: “Calculations of intrinsic value, though all-important, are necessarily imprecise and often seriously wrong. The more uncertain the future of a business, the more possibility there is that the calculation will be wildly off-base.”
In Buffett’s 1961 letter to shareholders, he mentioned “This is one thing from which I have always shied away and I still do in the normal sense. I am certainly not going to predict what general business or the stock market are going to do in the next year or two since I don’t have the faintest idea.”
He explored in Buffett’s 1962 letter to shareholders “I am not in the business of predicting general stock market or business fluctuations. If you think I can do
this, or think it is essential to an investment program, you should not be in the partnership.”
Closing words
Regardless, understanding the difference between risk and ambiguity is important for thinking clearly. Only in very few areas can one rely on clear probabilities. Generally speaking, all we have is an annoying ambiguity that we have to learn to live with.
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