# Can you reduce the risk involved in an uncertain event?

I'm not sure if this is the right Stack Exchange site but I felt it came closest.

Based on Knights 1971 definition of risk uncertainty is defined as a situation where factors exogenous to the decision making process impact that event. The example given in his book is when an individual knows there are red and blue balls in a bucket but is unaware there are 5 red balls compared to 3 blue ball. He wrongly (due to uncertainty) assumes he has a 0.5 chance of picking red. In contrast to this risk can only be used when the uncertainty surrounding an event has been defined using a probability distribution. Using the above example another individual would face risk if he knew the distribution of balls in the bucket.

So my question is what do you call it when you reduce the probability that a hazard will occur from an uncertain event. For example say in the above game you won £20 when you picked a red ball and lost £20 when you picked a blue ball. Would you still say you were reducing risk if say you changed the rules of the game so you get to pick three times and you only lose £20 if you pick all three blue balls. The situation is still uncertain but have you not reduced the probability of losing?

• Many, many researchers and practitioners of risk assessment today would dispute the assumption that "risk can only be used when the uncertainty surrounding an event has been defined using a probability distribution." See almost any issue of Risk Analysis for counterexamples.
– whuber
Commented Apr 23, 2015 at 14:20
• @whuber Thanks for the comment. So what would the modern definition of risk be and how is that separated from uncertainty? Thanks for your help, its very hard to find cohesive information on this topic Commented Apr 23, 2015 at 14:36
• Recent work is represented in a draft glossary by the Society for Risk Analysis. It currently provides seven definitional interpretations of the ISO definition of "risk as the effect of uncertainty on objectives." Although several of these interpretations invoke probability, several do not, instead using words like "possibility," "potential," and "uncertainty." In the literature the latter have been quantified in various non-probabilistic ways, such as fuzziness, "info-gap" measures, "possibility distributions," intervals, and others.
– whuber
Commented Apr 23, 2015 at 14:53
• Thank you, that glossary is incredibly helpful. Could you write up that comment as an answer and I can accept it. Commented Apr 23, 2015 at 14:55
• Thank you, but I do not see how my comments actually answer your question, which currently is "what do you call it when you reduce the probability that a hazard will occur from an uncertain event?"
– whuber
Commented Apr 23, 2015 at 14:56

## 1 Answer

The following may help:

(a) Frank Knight's seminal work on risk versus uncertainty is arguably his book "Risk, Uncertainty and Profit" published in 1921. Risk managers often use the terms "risk" and "uncertainty" largely interchangeably (in line with how they are used by the general public). However, when they do attempt to differentiate between these two terms then they usually do so in the way that he did in his book, using the term "uncertainty" in a similar sense to how economists use the term "Knightian uncertainty" (this link should provide a definition of this term and should also take you to further information on Knight's book).

(b) In his book, Knight focused on the relevance of this distinction to business life, especially the role of entrepreneurs. Suppose we toss a fair coin. Then we can identify the (exact) probability of the coin coming up heads. But suppose we are a smartphone manufacturer and we decide to launch a new smartphone. It is not normally possible to know in advance exactly how profitable a new product will be or even to quantify accurately the probability of any given level of profitability being achieved. The outcome is inherently "uncertain" (i.e. even the probabilities involved cannot be accurately quantified) and not just "risky", using his terminology. Knight's insight was to realise that entrepreneurs do this all the time, presumably hoping to gain some reward over time from doing so.

(c) So to answer your title question, one way of reducing the risk involved in an uncertain event is to avoid being "entrepreneurial", e.g. if you are a smartphone manufacturer then you could stop bringing out any new smartphones on the grounds that this minimises your likelihood of failure. Of course, shareholders may take a dim view if a firm adopts such a strategy across its entire range of business activities, because (as Frank Knight noted) some element of entrepreneurship is in the nature of doing business.

(d) You also ask "what do you call it when you reduce the probability that a hazard will occur from an uncertain event". Presumably by "hazard" you mean "suffering a negative impact from the event". You can reduce the probability of this occurring by "hedging" the risk / uncertainty or by "taking out insurance" against the risk / uncertainty etc.. Of course, in a business context doing so usually involves giving up some of the potential upside that might otherwise accrue from the uncertain event.

• Hi, thank you very much for your answer; part a) and b) are a really nice summary. In terms of part d) I assumed a similar definition of hazard to you. So your answer is that its called 'hedging the risk' or `hedging the uncertainty' as they are both interchangable? Is this term equivalent to reducing the risk: is hedging not just one way of reducing risk/uncertainty? The example I gave reduced risk without hedging. Thanks for any clarification you can provide. Commented Apr 24, 2015 at 7:41
• I'm not aware of there being any specific term for changing the rules of a game so that the likelihoods of different outcomes are changed (as in your example). Usually the assumption is that you will be facing some risks or uncertainties and you want somehow to respond to them e.g. by reducing the negative impact they might have on you. There is no single (technical) term that captures all possible responses. "Hedging", if used generically, would capture many potential responses, although it can also be used in the more technical sense of entering into an additional offsetting transaction. Commented Apr 24, 2015 at 10:30
• So to apply this to a real world scenario. Im a farmer facing climate change and associated uncertainty about droughts, wet periods, temperature changes etc. If I add irrigation am I reducing risks of my crops failing due to climate change? Hedging risks doesn't seem to make sense in this analogy. As you mention it may be that there just isnt a term for it. I guess it could also be referred to as reducing vulnerability to states which are uncertain. Commented Apr 24, 2015 at 10:57