Risk, uncertainty and confidence
Stephen Bounds — Tue, 08/11/2011 - 23:29
I read the following today:
[Risk, traditionally formulated, is a quantifiable metric, while] uncertainty is risk that is immeasurable, not possible to calculate. [However, both] risk and uncertainty are about expectations ...
If we cannot frame sufficient expectations, we have no basis on which to act ... Uncertainty is fundamentally based on information, because our ability to calculate risk is a function of the information available ... The centrality of expectations to action ... is why law and economics analysis by people such as Richard Posner has been so fruitful; law is all about creating pattern and structure to frame expectations ... the two key insights of C20th economics—transaction costs matter and information and action are not separable.
Just because something cannot be calculated does not mean we will not frame expectations to cover that uncertainty: it just means that such expectations cover more than is directly inferable from such information as we have ... “confidence” ... is, to a large degree, how what cannot be calculated is being framed in a given time period ...
The wider the range of uncertainty ... the more unstable confidence is likely to be ... If confidence is how we frame uncertainty ... then it is a central obligation of a [regulator like a central] bank to narrow such uncertainty, to [publish] a clear [framework] for ... agents to frame their actions.
— On the stupidity of (some) Central Banks:
The idea of uncertainty (or how many "unknown unknowns" there are) is a concept that is well understood by KM people. Fundamentally we accept complexity theory and the notion of root unpredictability as key to the understanding of modern organisations.
However, the use of "confidence" to describe how uncertainty is treated is novel (to me at least). And it's a powerful visual and tool.
Dave Snowden often talks about coherence when dealing with complexity and uncertainty. Coherence refers to a state that is "consistent with a view of what has happened and what could happen in the future".
This continuum of possibilities is key to managing uncertainty. Even if we don't know how to predict the likelihood of outcomes, we can still draw reasonable boundaries around possibilities. For example, changing an incentive payment to my company's staff won't make the 737 flying overhead fall out of the sky the next day.
So accurately evaluating uncertainty is just as important as managing risk. Knowing that a maintenance technique completely isolates a system from catastrophic failure may be more important than the fact that it only has a 40% chance of success. As another example, the subprime crisis would have been far less severe if the financial instruments had been regulated to ensure an upper bound on possible losses. It was the uncertainty about the location and magnitude of losses which froze financial markets across the globe.
Even where risk cannot be quantitatively specified, bounding uncertainty still increases confidence. It's a key technique for enabling innovation and change and one that we should consciously embrace more often.
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