Radical Uncertainty: Decision-making for an unknowable future

by John Kay

Long Term Capital Management collapsed but Berkshire Hathaway became the largest investment company in the world. It seems that ecological rationality has performed better than optimising rationality.

evolution favours those who survive, and they are not necessarily those who maximise expected value.

Reasoning is part of decision-making, but reasoning is not decision-making, nor decision-making reasoning. Decision-making describes the choice of actions, reasoning is how we explain those choices to ourselves, and to others.

The Economist examined country forecasts made by the International Monetary Fund (IMF) in its Spring World Economic Outlook. Of the 207 recessions – defined as a fall in output between the year in which the forecast was made and the following year – the World Economic Outlook had predicted precisely none of them.

platitude

Monte Carlo simulation is a technique devised by nuclear physicists to allow the estimation of a joint probability distribution (of two or more variables) when the underlying probability distributions of each variable are known, but the joint probability distribution is too difficult to compute analytically.

is that models are rarely used as an input to the decision-making process; their purpose is to help justify an already determined course of action to corporate boards or government ministers or external regulators.

First, deploy simple models to identify the key factors that influence an assessment.

The useful purpose of modelling is to find ‘small world’ problems which illuminate part of the large world of radical uncertainty.

Second, having identified the parameters which are likely to make a significant difference to an assessment, undertake research to obtain evidence on the value of these parameters.

Third, simple models provide a flexibility which makes it much easier to explore the effects of modifications and alternatives.

Scenarios are always useful in conditions of radical uncertainty.

Fourth, under radical uncertainty, the options conferred by a policy may be crucial to its evaluation.

A map, or a model, is necessarily a simplification, and the appropriate simplification is matched to a purpose – a walking map differs from a subway map or road atlas, even of the same area.