Risk, uncertainty, and heuristics

Nearly a century ago, Frank Knight famously distinguished between risk and uncertainty with respect to the nature of decisions made in a business enterprise. He associated generating economic profit with making entrepreneurial decisions in the face of fundamental uncertainties. This uncertainty is complex because it cannot be reliably hedged unless it is reducible to risk. In making sense of uncertainty, the mathematics of probability that is used for risk calculations may lose relevance. Fast-and-frugal heuristics, on the other hand, provide robust strategies that can perform well under uncertainty. The present paper describes the structure and nature of such heuristics and provides conditions under which each class of heuristics performs successfully. Dealing with uncertainty requires knowledge but not necessarily an exhaustive use of information. In many business situations, effective heuristic decision-making deliberately ignores information and hence uses fewer resources. In an uncertain world, less often proves to be more. (C) 2014 Elsevier Inc. All rights reserved.