Introduction
Much is made of the difference between risk and uncertainty. Most people who make the distinction have not read the book they unknowingly cite in making this distinction: Frank Knight's classic Risk, Uncertainty, and Profit. We'll go through the main parts of the book (whose fulltext is here, for free), and illustrate some of the points of the book with episodes from historical finance.
We'll also talk about Herbert Simon, and the economic definition of rationality. These three concepts: risk, uncertainty, and rationality, are all used in specific ways in the modern theory of finance I'll be showing you in a few weeks' time, so it is best you learn them out of that context beforehand.
Length: 50 minutes.
Click the link to download the slides, handouts, etc.
Slides
Handouts
I'll distribute some photocopies in class for this lecture.
Readings
F. R. Knight, Risk, Uncertainty, and Profit (you need the MS Reader program to use this book file, but it is free and linked to on the book's page).
Herbert A. Simon, Rationality as Process and as Product of Thought, The American Economic Review, Vol. 68, No. 2, Papers and Proceedings of the Ninetieth Annual Meeting of the American Economic Association. (May, 1978), pp. 1-16.
Chapters 1 and 2 of:
"Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets" (Nassim Nicholas Taleb)
"Against the Gods: The Remarkable Story of Risk" (Peter L. Bernstein)