The Economics of Uncertainty

Professor Fullenkamp begins with "black swan" events - occurrences that are considered as improbable as black swans. A notable recent example is the 2008 financial crisis. This leads to an examination of the nature of uncertainty and the best strategy for dealing with it.

When faced with an uncertain situation, try turning it into a "risky" situation. Risk is probability. Knowledge is power. This may sound counterintuitive, but it's a surprisingly effective approach, pioneered by University of Chicago economist Frank Knight. See where it applies and does not apply in economic settings.

In dealing with uncertainty, it makes sense to have an arsenal of different strategies. Explore five techniques for risk management that can be used in every sphere of life: producing information, diversifying, sharing risk, avoiding risk, and absorbing risk. Probe instructive examples of each.

Examine two different types of probability. Frequency-based probabilities rely on many examples of a phenomenon, while subjective probabilities call on personal experience and judgment, often drawing on relatively few cases. Learn to think critically about these two approaches, and know when to use them.

Improve your ability to handle uncertainty by studying two ways that people reach decisions. System 1 excels at making snap judgments, while System 2 is analytical, methodical, and more time-consuming. Weigh the strengths and weaknesses of each, focusing on the problem of estimating probabilities.

Having learned to convert uncertainty to risk, now go deeper by investigating how probabilities can gauge rewards and risks. Test risk-assessing tools used in finance, including expected value, variance, standard deviation, coefficient of variation, Sharpe ratio, covariance, and beta.