Risk versus Uncertainty: Frank Knight’s “Brute” Facts of Economic Life

Risk versus Uncertainty: Frank Knight’s “Brute” Facts of Economic Life
Published on: Jun 07, 2006

Dr. William H. Janeway, Vice Chairman, Warburg Pincus, received his doctorate in economics from Cambridge University where he was a Marshall Scholar. He was Valedictorian of the Class of 1965 at Princeton University. Prior to joining Warburg Pincus in 1988, where he was responsible for building the Information Technology practice, he was Executive Vice President and Director at Eberstadt Fleming. Dr. Janeway is a director of BEA Systems, Manugistics, Scansoft and UGS. He is also a member of the board of directors of the Social Science Research Council and a member of the board of Trustees of Cambridge in America, University of Cambridge. He is a Founder Member of the Board of Managers of the Cambridge Endowment for Research in Finance (CERF).

“…there are known knowns; there are things we know we know. We also know there are known unknowns; that is to say we know there are some things we do not know. But there are also unknown unknowns—the ones we don’t know we don’t know.”—Donald Rumsfeld

“Ah, what a dusty answer gets the soul, When hot for certainties in this our life”—George Meredith

Donald Rumsfeld’s characteristically idiosyncratic gloss on George Meredith’s existential meditation attracted derision across many constituencies. But Rumsfeld summarized a way of structuring our understanding of the world that has profound and immediate relevance. Most particularly, over the past generation, the application of increasingly powerful and sophisticated computerized statistical analysis has interacted with the work of theoreticians of finance to transform the capital markets in the U.S. and around the world. Our mastery of “known unknowns”—i.e., well-defined probabilities—has increased enormously, transformationally. The measurement and management of “risk” has become a major concern of all financial institutions and their regulators, especially since the collapse of Long Term Capital Management (LTCM) in 1998. At the same time, proposals to privatize Social Security and, more generally, to rely on “risk-managed” financial markets for economic security find their theoretical rationalization in the teachings of “modern” finance. And yet, as Rumsfeld and Meredith assert in their very different ways, there is another category of the world’s possible outcomes that lies beyond the reach of modern, market-based, risk management techniques.

More than eighty years ago, Frank Knight set out to parse the difference between risk and uncertainty and the significance of that difference. In Risk, Uncertainty and Profit, Knight distinguished between three different types of probability, which he termed: “a priori probability”; “statistical probability” and “estimates”. The first type “is on the same logical plane as the propositions of mathematics”; the canonical example is the odds of rolling any number on a die. “Statistical probability” depends upon the “empirical evaluation of the frequency of association between predicates” and on “the empirical classification of instances”. When “there is no valid basis of any kind for classifying instances”, only “estimates” can be made.1 In contemporary Bayesian parlance, in the first case, the probability distribution of the prior and all its moments are known definitionally; in the second case they are specified by statistical analysis of well-defined empirical data; in the third case such data as exists do not lend themselves to statistical analysis. Continue reading

Hayek and Market Socialism: Science, Ideology, and Public Policy



from http://mises.org/story/1661

Mises Daily by 

The Hayek Memorial Lecture, London School of Economics, presented in cooperation with the Mises Institute, October 19, 2004. Also available in pdf.


It is a great honor for me to have this opportunity to speak at this great institution of economic education and research,[1] and on this occasion to honor F.A. Hayek—a scholar who I admire greatly as a man of keen intellect and courage. Hayek’s scholarly career spanned from the 1920s to the 1980s, and he had appointments at several universities, but the LSE was the school where he taught at for the longest period, and where his own ideas took shape. I want to thank the staff at LSE for coordinating my visit, Professor Tim Besley for being a gracious and welcoming host, and Mr. Toby Baxendale for his respect for the ideas of the LSE tradition ofCannan, Robbins, Plant, Hayek, Coase and P.T. Bauer, and for his vision of how these ideas can be revitalized and advanced at this great institution of higher learning to both improve our understanding and realize a freer and more economically prosperous state of affairs in Britain and abroad.

I have chosen as my topic “Hayek and Market Socialism,” and I have done so for a variety of reasons:

  • It is in this debate that Hayek’s research program in philosophy, politics, and economics emerged;
  • Hayek’s main contributions to this controversy were written while he was here at the LSE;
  • The topic is not an example of ‘beating a dead horse’ because the subtlety of Hayek’s argument is not fully appreciated and its relevance to contemporary debates in public policy is not generally recognized.

In the interest of being completely frank, I should add that I also recently had occasion to revisit this episode in Hayek’s career for a series of professional publication opportunities.[2]

The basic argument of my talk will proceed as follows:

  • Hayek’s critique of socialism was grounded in his scientific understanding of economics.
  • Hayek’s ideological commitment to liberalism was a consequence of his science, and not the other way around.
  • Hayek’s position in this debate had direct policy relevance during his life, and it still has lasting relevance today for public policy. We must resist the general consensus that appreciates Hayek as an ideological icon, rather than as the source for a series of scientific propositions. It is my contention that if Hayek’s scientific contribution were understood, then economics as a discipline would be transformed in both its theoretical and empirical orientation. Continue reading

章诒和: 卧底


章诒和: 卧底



我觉得自己经历了许多事,心已变硬,情也冷去。不想“卧底”的事如滔天巨浪,将我击倒在地。一连数日,泪流不止,大汗不止。文史专家、学者朱正先生告诉我:情况确凿,证据就是冯亦代在生前以极大勇气出版的《悔余日录》(河南人民,2000;下引本书只注日期和页码)。读后,全身瘫软,一张报纸都举它不起。因为他的这个“角色”,与章家两代人交往的深情厚谊以及那笑脸后面的一片慈祥,在我是无论如何也联系不上。可证据就摆在那里 ,你不信也得信,你无法接受也要接受。难道伤天害理之灾,裂骨锥心之痛,就是我的命运?





冯亦代说:“李大姐,我能好到哪里去呢?” Continue reading

Treasury’s Rules of the Road for Regulatory Reform

Davis Polk & Wardwell‘s recent memorandum, entitled “Treasury’s Rules of the Road for Regulatory Reform,” describes Treasury’s framework for regulatory reform, focusing on the comparatively more detailed proposals for addressing systemic risk, and sets forth some of the issues the government and the private sector may consider as the details are hammered out.


Cass R. Sunstein, The Enlarged Republic—Then and Now


NY Books, Volume 56, Number 5 · March 26, 2009

The Enlarged Republic—Then and Now


By Cass R. Sunstein



To many modern readers, the Federalist Papers seem formal, musty, old, and a bit tired—a little like a national holiday that celebrates events long past but lacks any sense of struggle and excitement, or even a clear message. But under stringent time pressure, starting in October 1787, Alexander Hamilton, James Madison, and John Jay, writing under the name of “Publius,” produced the best historical record, by far, of the uniquely American contribution to political thought and practice.


It is important to see that their arguments were a product of a concrete historical drama, involving the fate of an emerging nation that was having an exceedingly difficult time governing itself. But Publius’s claims bear not only on American debates of the eighteenth century, but also on those of the nineteenth, twentieth, and twenty-first. They offer lessons for making war and making peace, and for domestic crises of many different kinds. Indeed, they provide guidance for constitutional democracies elsewhere, not least when peace and prosperity are endangered.

Continue reading







  间:民国九十二年六月六日 晚间七时至九时

  点:台北大学建国校区 社会科学馆一楼 阶梯教室

  录:陈怡秀 小姐



  Continue reading


The Welcome Reaffirmation of the Business Judgment Protection

(Editor’s Note: This post is based on a client memorandum by Martin Lipton, Steven A. Rosenblum, and Sabastian V. Niles of Wachtell, Lipton, Rosen & Katz.)

Despite increasing political and media focus on and criticism of risk assessment and risk management efforts by corporate boards, yesterday’s In Re Citigroup Inc. Shareholder Derivative Litigation, No. 3338-CC (Feb. 24, 2009), decision by the Delaware Court of Chancery is a welcome indication that the business judgment rule will survive the financial crisis intact. Continue reading

Lessons from the Financial Crisis

Lessons from the Financial Crisis

(Editor’s Note: This post comes from Mats Isaksson of the Organization for Economic Co-operation and Development.)

The OECD Steering group has recently issued a report entitled “Corporate Governance Lessons from the Financial Crisis.”

This Report concludes that the financial crisis can be to an important extent attributed to failures and weaknesses in corporate governance arrangements. When they were put to a test, corporate governance routines did not serve their purpose to safeguard against excessive risk taking in a number of financial services companies. A number of weaknesses have been apparent. The risk management systems have failed in many cases due to corporate governance procedures rather than the inadequacy of computer models alone: information about exposures in a number of cases did not reach the board and even senior levels of management, while risk management was often activity rather than enterprise-based. These are board responsibilities. In other cases, boards had approved strategy but then did not establish suitable metrics to monitor its implementation. Company disclosures about foreseeable risk factors and about the systems in place for monitoring and managing risk have also left a lot to be desired even though this is a key element of the Principles. Accounting standards and regulatory requirements have also proved insufficient in some areas leading the relevant standard setters to undertake a review. Last but not least, remuneration systems have in a number of cases not been closely related to the strategy and risk appetite of the company and its longer term interests.

The Report also suggests that the importance of qualified board oversight, and robust risk management including reference to widely accepted standards is not limited to financial institutions. It is also an essential, but often neglected, governance aspect in large, complex non-financial companies. Potential weaknesses in board composition and competence have been apparent for some time and widely debated. The remuneration of boards and senior management also remains a highly controversial issue in many OECD countries.

The current turmoil suggests a need for the OECD, through the Steering Group on Corporate Governance, to re-examine the adequacy of its corporate governance principles in these key areas in order to judge whether additional guidance and/or clarification is needed. In some cases, implementation might be lacking and documentation about the existing situation and the likely causes would be important. There might also be a need to revise some advice and examples contained in the OECD Methodology for Assessing the Implementation of the OECD Principles of Corporate Governance.

The full report can be found here.

Rights Talk: Two Quotes (福柯和米秾教授谈权利理论)


1. from Two Lectures Power/Knowledge (Foucault):

The essential role of the theory of right, from medieval times onwards, was to fix the legitimacy of power; that is the major problem around which the whole theory of right and sovereignty is organized. When we say that sovereignty is the central problem of right in Western societies, what we mean basically is that the essential function of the discourse and techniques of right has been to efface the domination intrinsic to power in order to present the latter at the level of appearance under two different aspects: on the one hand, as the legitimate rights of sovereignty, and on the other, as the legal obligation to obey it. The system of right is centered entirely upon the King, and it is therefore designed to eliminate the fact of domination and its consequences.

2.from Martha Minow, Interpreting Rights: An Essay for Robert Cover,
Yale Law Journal 96 (1987): 1860-1915, 1867.

“Rights” can give rise to “rights consciousness” so that individuals and groups may imagine and act in light of rights that have not been formally recognized or enforced. Rights, in this sense, are neither limited to nor-coextensive with precisely those rules formally announced and enforced by public authorities. Instead, rights represent articulations — public or private, formal or informal — of claims that people use to persuade others (and themselves) about how they should be treated and about what they should be granted. I mean, then, to include within the ambit of rights discourse all efforts to claim new rights, to resist and alter official state action that fails to acknowledge such rights, and to construct communities apart from
the state to nurture new conceptions of rights. Rights here encompass even those claims that lose, or have lost in the past, if they continue to represent claims that muster people’s hopes and articulate their continuing efforts to persuade.