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.

Simplify Decisions by understanding Tasks and Amusements

I propose that whatever we do in our time should be categorised either as Task or an Amusement. I would define task is defined as something that will give us a tangible output on completion – skill, knowledge, health or material benefits. Everything much else such as listening to music, watching Sports, listening breaking news, surfing internet, reading fiction can be termed into amusement. One of the grey areas which falls between the two categories is the relationship with family and close friends. They form a core of one’s being and if one is cynical can term them as essential for a proper mental health and the time spent with them as a Task or amusement. Anyways, in any case they would fit into an individual’s definition based on his priority.

Premise
The fact that the only asset that we human beings have is our brain and developing it to think rationally and applying it has lead to a gradual progress in various spheres. Thus, the function of progress is application of brains to achieve tangible results. Amusements were invented to refresh the brain and make it more effective in applying to problems.

Enabling Decision
Coming back to the main point – This elegant categorisation makes one realise where is one heading and take optimum decisions. It simplifies choice. Consider, the choice between watching an IPL match and learning how to write effectively. I would prefer an IPL match. But then wait a second, isn’t it just another way to amuse myself. Aren’t there a large number of choices available to me to amuse myself at my will when I would like to do it. Why then I feel so strongly for watching the IPL? I guess its the magical marketing phenomenon that has made the amusements as a ‘must have’ and someone who is not following these amusements is considered boring, bookish or nerd. But my belief with those the real progress is brought around by such smart people who have Skills and I am not alone. Consider the speeches made by Bill Gates and this video from University of Minnesota

The idea is to realise the importance of the things we are doing and then make an appropriate choice rather than being driven in the herd.

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.