I’ll Take That Bet .com
[Pages:88]The Human Side of Science: I'll Take That Bet! Balancing Risk and Benefit
Uncertainty, Risk and Probability: Fundamental Definitions and Concepts
What Is Uncertainty?
A state of having limited knowledge where it is impossible to exactly describe the existing state or future outcomes
Franklin's Law
Certainty? In this world nothing is certain but death and taxes.
-- Ben Franklin (1706-1790)
Berra's Law
It's tough to make predictions, especially about the future.
- Yogi Berra (1925 - 2015)
Risk vs. Uncertainty
Uncertainty must be taken in a
sense radically distinct from the
familiar notion of Risk, from which
it has never been properly
separated ... a measurable
uncertainty, or "risk" proper ...
is so far different from an unmeasurable one that it is not
Frank H. Knight (1885-1972)
in effect an uncertainty at all.
- Frank H. Knight, University of Chicago Risk, Uncertainty and Profit, 1921
How Do We Measure Uncertainty?
- Assign probabilities to each possible state or outcome
- Example: What will the weather be tomorrow? ... 40% chance of rain ... 60% chance of sunshine
What is Risk?
- A state of measured uncertainty where some outcomes have an undesirable impact or entail significant losses
- Quantifying risk involves determining: ... Probability that each outcome will occur ... Size of impact or loss for each outcome ... Outcome's expected value = probability x impact
- Example: If it rains tomorrow, my wedding will be ruined! ... Probability: 40% (based on weather report) ... Cost: -$20,000 ... Expected value of rain: 40% x -$20,000 = -$8,000
Risk vs. Time
- Long run risks are different than short run risks
... Example: Would you invest $25,000 in a venture start-up if you were 35 years old? If you were 70 years old?
... Example: Which is worse ? a 50% chance of losing $10,000 now, or a 50% chance of losing $10,000 in 5 years?
- Why is this? ... Discounted present value of money ... Psychology
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