An Evolutionary Perspective On The Concept Of Risk, Uncertainty And Risk Management

This chapter aims to provide a conceptual framework on risk and uncertainty, with the goal of helping the reader gain a better understanding of how risk is measured and managed. Beginning with Luca Pacioli until the recent development in the discipline of risk management, the theoretical and historical framework is built around the concept of risk and uncertainty. The major contribution of the Classical Economics School is analyzed in order to investigate the relationship between profit and uncertainty. Throughout the five centuries which separate Luca Pacioli from the present, scholars have shared some common thoughts and ideas on the subject of risk and uncertainty. However several notable judgments still remain. This chapter illustrates the beliefs of Marginalists in the insignificant role of risk management in the progress of the society. As a consequence, the Marginalists, aware of the potential negative effects of including risk and uncertainty in their models, chose to avoid the problem by relegating them to simple assumptions. Later in the chapter, it is shown that in the 19th century the study of risk re-emerged drawing the attention of several scholars to uncertainty in the production process. The subsequent part of the chapter is dedicated to the systematization of the concepts developed in the last century by the respected academic scholar, Frank Knight. Since 1921, both scholars and practitioners have widely investigated the relationship between risk and return in order to determine if investors are well rewarded for the risk they retain. The final part of the chapter includes the contribution of Markowitz to the subject of portfolio selection and diversification, and that of Sharpe and Lintner to the areas of capital asset pricing. It also includes contributions of other followers framed in the modern theory of Finance. This leads us to the conclusions where risk management is shown as an independent discipline in the field of finance.