Quantitative Risk Management: A Practical Guide to Financial Risk, + Website

2.3 Randomness and the Illusion of Certainty

Thinking about uncertainty and randomness is hard, if only because it is more difficult to think about what we do not know than about what we do. Life would be easier if risk could be reduced to a single number, but it cannot be. There is a human tendency and a strong temptation to distill future uncertainty and contingency down to a single, definitive number, providing the illusion of certainty. But many mistakes and misunderstandings ensue when one ignores future contingency and relies on a fixed number to represent the changeable future. The search for a single risk number is an example of the human characteristic of trying to reduce a complex, multifaceted world to a single factor.

To understand, appreciate, and work with risk, we have to move away from rigid, fixed thinking and expand to consider alternatives. We must give up any illusion that there is certainty in this world and embrace the future as fluid, changeable, and contingent. In the words of Gigerenzer (2002), “Giving up the illusion of certainty enables us to enjoy and explore the complexity of the world in which we live” (p. 231).

Difficulties with Human Intuition

Randomness pervades our world, but human intuition is not very good at working with randomness and probabilities. Experience and training do not always groom us to understand or live comfortably with uncertainty. In fact, a whole industry and literature are based on studying how people make mistakes when thinking ...