- Modern society’s misconception that uncertainty can be transformed into calculable risks is examined in the book “Radical Uncertainty” by economists John Kay and Mervyn King.
- Ancient Greeks did not study probability theory because they believed events were determined by the gods, and there was no place for chance or probability in their thinking.
- The foundation of probability theory was laid in the 17th century as a response to a question posed by a passionate gambler, Antoine Gombaud, Chevalier de Méré, to the renowned French mathematician Blaise Pascal.
- University of Chicago economist Frank Knight introduced the concept of “radical uncertainty” in 1921, distinguishing it from measurable uncertainty or risk.
- John Maynard Keynes and other mathematicians differed in their conclusions about the calculability of future scenarios and the existence of radical uncertainty.
- According to Friedrich Hayek, economic decisions are based on subjective knowledge of facts and relationships that are not objectively or mathematically graspable.
- The dominance of subjective probabilities over radical uncertainty in economic discourse led to the impasse in modern finance.
Exploring the Roots of Probability Theory in Financial Uncertainty
Radical Uncertainty” is a remarkable book by economist and former Financial Times columnist John Kay and former Bank of England (BOE) governor Mervyn King. They discuss modern society’s illusion that uncertainty can be transformed into calculable risks. They build on the theme explored by the late German sociologist Ulrich Beck, who suggested that the world of calculable and controllable risk liberates the moment of surprise.
The ancient Greeks, gifted mathematicians, did not study probability theory because they believed events were determined by the gods. Mathematics offered no help in understanding the will of the gods.
Probability theory began in response to a question from a passionate gambler, Antoine Gombaud, Chevalier de Méré, to the renowned French mathematician Blaise Pascal. This led to the foundation of probability theory in the 17th century, with its birthplace at the gaming tables.
The concept of “radical uncertainty” was introduced by Frank Knight in 1921, distinguishing it from measurable uncertainty or risk. Knight observed that the metrics developed for games of chance were not applicable to radical uncertainty.
John Maynard Keynes and other mathematicians had different conclusions about the calculability of future scenarios and the existence of radical uncertainty. This led to the dominance of subjective probabilities over radical uncertainty in economic discourse and created an impasse in modern finance.
The next installment in this series will delve into how this impasse led to the challenges in modern finance.
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*All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.*
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