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Proper definitions for Risk and Uncertainty (July update with (a) better notation, (b) relative risk (c) an application to insurance)

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  • Thomas Cool

    (Consultancy & Econometrics)

Abstract

The commonly adopted definitions of risk and uncertainty generate conceptual problems and inconsistencies, and they are a source of confusion in general. However, alternative and proper definitions are: (1) First there is the distinction between certainty and uncertainty. (2) Uncertainty forks into known (assumed) and unknown probabilities. (3) Unknown probabilities forks into known categories and unknown categories. (4) Known categories forks into 'including the uncertainties in the probabilities by explicitly assuming a uniform distribution' (Laplace) or neglect (or use other non-probabilistic techniques). Note that the term 'risk' has not been used in the 4 points above, so that an independent definition is possible. 'Risk' can be defined as the absolute value of probable loss, i.e. as rho = -E[x

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Bibliographic Info

Paper provided by EconWPA in its series General Economics and Teaching with number 9902002.

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Date of creation: 25 Feb 1993
Date of revision: 08 Jul 1999
Handle: RePEc:wpa:wuwpgt:9902002

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