Business Finance: Dealing with Uncertainty

Abstract

Economic theory has a long tradition of interest in risk and uncertainty. The relevance of these concepts for the understanding of entrepreneurship and the analysis of market mechanisms was recognized as early as 1921 in the famous book by Frank H. Knight on Risk, Uncertainty and Profit. In line with the neo-classical tradition Knight stated:

If all changes were to take place in accordance with invariable and universally known laws, they could be foreseen for an indefinite period in advance of their occurrence, and would not upset the perfect apportionment of product values among the contributing agencies, and profit (or loss) would not arise. Hence it is our imperfect knowledge of the future, a consequence of change, not change as such, which is crucial for the understanding of our problem [Knight, p. 198].

It is a world of change we live in, and a world of uncertainty. We live only by knowing something about the future; while the problems of life, or of conduct at least, arise from the fact that we know so little [Knight, p. 199].

After a careful and interesting analysis Knight concludes a distinction between measurable uncertainty and unmeasurable uncertainty.