I think it’s useful for everyone to clearly define some of the key concepts and ideas used in this blog and elsewhere in the world of risk, foresight and uncertainty. I’ve drawn these definitions from disparate sources and my own (sometimes addled) brain, so please offer comments and suggestions for improvements. As such, this page is most definitely a work in progress – where no definition exists, that means I haven’t yet quite got around to it yet. Feel free also to suggest other words to define and debate.
In the way I normally use the word, a scenario is a plausible, coherent, story about the future, used purposefully to challenge assumptions, test strategies or elicit insight in relation to a specific question or problem. I primarily produce qualitative scenarios, which involve relatively little modelling (see here), but it is very possible to produce a scenario which comprises a series of quantifications about future states – the trick is not being seduced into the world of forecasting (and hence the “precisely wrong”). In my world, we shy away from assigning probabilities to scenarios, as we regard our scenarios to deal with uncertainty as opposed to risk (see below).
Wikipedia defines risk quite nicely as “the precise probability of specific eventualities”. It does not necessarily imply loss, although many will take it that way. As I use it, however, it does imply a quantification and assessment of probability.
Uncertainty is not a simple concept. At its core, uncertainty is a state of lack of knowledge. However uncertainty can take different forms, including doubt about one’s own knowledge and doubt about the outcome of a specific event. In a way, uncertainty is defined by what it isn’t – certainty, and has been distinguished by some from the concept of “risk”:
“Uncertainty must be taken in a sense radically distinct from the familiar notion of risk, from which it has never been properly separated…. The essential fact is that ‘risk’ means in some cases a quantity susceptible of measurement, while at other times it is something distinctly not of this character; and there are far-reaching and crucial differences in the bearings of the phenomena depending on which of the two is really present and operating…. It will appear that a measurable uncertainty, or ‘risk’ proper, as we shall use the term, is so far different from an unmeasurable one that it is not in effect an uncertainty at all.” From Wikipedia, quoting Frank Knight (Knight, F.H. (1921) Risk, Uncertainty, and Profit. Boston, MA: Hart, Schaffner & Marx; Houghton Mifflin Company)
This is a concept and phrase made popular by Nassim Nicholas Taleb in his book of the same name. According to him, a black swan is an event that has high impact, is rare and is beyond the realm of normal expectations. As Wikipedia notes, examples of black swans include the rise of the Internet, the First World War, September 11, and the impact of many disruptive technologies. In my opinion the recent financial crisis wasn’t a black swan overall (clear and compelling data existed and many people predicted it), but to many actors in the financial sector (given prevailing mindsets and the tools employed for risk management), it would qualify. According to Taleb, one of the hallmarks of a black swan is that it is explained as entirely knowable in hindsight.