Taming Uncertainty

Director of the Center of Adaptive Rationality (ARC), Max Planck Institute for Human Development


In real life we overwhelmingly deal with situations of uncertainty rather than situations of risk (with risk being situations in which we know possible outcomes of our behaviors and their probabilities). In situations of uncertainty, however, surprises can happen, meaning unexpected / unpredicted events happen. Most of our models, however, including models of risk in investment decisions are models that assumes that probabilities are known or can be reasonably estimated.

In the world of uncertainty, unlike in world of risks, simple strategies—heuristics— perform surprisingly well—in fact they often outperform computationally more complex models

The speaker will illustrate this conjecture

(a) in the world of strategic interactions

(b) in investment decisions (Markowitz’s mean variance model vs. 1/N naive diversification

(c) in investment decisions by laypeople (risk simulator)

(d) across a range of business decisions (e.g., hiatus heuristic).

Finally, the speaker will also point out the limits of heuristic decision making.