Uncertainity vs. Risk: Whats the Difference?

Whats the difference between the Two? Are not they synonyms? Dr. Andrew Lo asks this question to his audience in the video. Andrew Lo terms Risk as anything that can be quantified with certainity or predicted with certainity. Uncertainity is anything that cannot be predicted. For example, the risk of opening a new office for an FMCG company can be predicted and quantified. However, the uncertainity of doing business in Nanotechnology cannot be predicted, hence, it is uncertain. He then goes on to prove that rewards are maximum in the markets and industries with uncertainity rather than those with high risk.

He is giving a lecture to prove that Economics unlike Physics involves uncertainity (because of human emotions), hence, the tools of Physics – Mathematics – do not provide a accurate results while making decisions about markets as it involves human decisions. He says that the quant in Economics cannot be berated for the economic crisis – rather its limitations should be understood. Similarly, other fields of study can be categorised on the scale of uncertainity, where, Mathematics and Physics forms one end of the spectrum where we are certain and Philosophy and Religion on the other end where we are uncertain about meaning of life etc.

The overarching message is that the limitations of using certain tools should be realised. And in such cases a mental checklist of various other parameters apart from mathematics must be used. A very important point explained simply.

Physics, Economics, and Mathematics

Maths
Learning a Language makes one literate. Learning Maths and using it everyday makes one numerate. Most people who are literate could be innumerate.

Maths is a vital tool in helping us making choice as it allows us to understand, measure, and takes the decision. A cynical example of applying maths to measure corruption:- India ranks among the worst countries in corruption. The extent of the involvement of Government is all surpassing. Everyone needs to bribe the small officials here and there. The big corporations who enter India have to grease palms of the big politicians. The money usually goes to a number of people in the hierarchy at different point and times. Assuming, that the overall expense to the headcount ‘bribery’ is conservatively 20% of the overall investments or income of a firm and accounting for the fact that the size of the national economy was USD 1 Trillion – Bribery can be conservatively estimated to be a lucrative market worth USD 200 billion growing atleast 7-8% YOY. The best part is that it is a monopoly and cooperative run by 500 parliamentarians and the bureaucracy. (The market doesn’t take into account the equally big shadow economy where the % age would be higher). its a completely domestic market with no seasonality. Do note that since this is a monopoly the size of this market is equal to the revenue of the “Co-op of Swindlers of India”. Compare this USD 200 bn revenue of this corporation compared to the revenue of the huge Tata Group which is USD 50 bn or one of the biggest employers in India Infosys whose revenue is USD 5bn.

Consider the amount of money stashed with some of the politicians who have been in the business for long.

Physics
The most striking revelation to me was that everything around me is basically made of atoms and cells. The chair is a collection of atoms, so is the laptop, the book, the ink, the glass. Analogically, I realised that the human scientific investigation and emperical analysis has been to understand the properties of these atoms and then mould them to our own use – which is what we call physics. The study of physics lead us to reason, logic and understanding the cause of things around us – nothing is more satisfying and fascinating then to answer the Whys!

Economics
Economics is to humans what Physics is to objects. Economics tries to understand Human Behavior against choices. Humans are much tougher to study because a large part of decisions flow from emotions and feelings – thus Economics always follow a caveat that it studies the choices made by rational human beings. Nevertheless, it allows insights into behaviours individually and groups and answer another large number of Whys.

Of Inequities, Complexities and Solutions

Poverty, Illiteracy, Child Mortality seem distant and difficult to recognise when one sees it all around from childhood. The average is closer to the normal. One gets the real experience after coming from abroad or living in a city like Gurgaon. The scale of inequity is exponential. High towers neighbour small dingys and slums. Naked children prostate on the bonet of air conditioned cars begging their share of the prosperity.

The inequities are huge with the development indicators for some of our population as low as that of sub-saharan Africa and others as high as that of a developed OECD region. The complex question is how can one single individual assist in removing these blots in a sustainable manner. The question becomes complex as the sheer size of the numbers who are in need of help is quiet large. A drop of water rather even a complete tanker of water in the barren deserts will not be of any help.

The problem is structural and needs to be tackled accordingly, I have always believed that funding people directly is not a good idea and not sustainable. Creating a framework that allows multiple generations to become self sufficient and further spread the reach is essential. But the next question is what is that framework? Is it to create entrepreneurs through micro financing, to initiate education in the region, to bring guaranteed employment to the people, to provide health care facilities? Which one of these have a maximum impact and start a chain reaction that alleviates the evils? How can technology help?