What’s the difference between risk and uncertainty?
When cognitive scientist Gerd Gigerenzer toured Daimler-Benz Aerospace, maker of the Ariane rocket, he noticed a poster tracking the performance of all 94 launches of Ariane 4 and 5. The poster showed eight accidents. When Gigerenzer asked why, the guide replied the security factor was around 99.6%.
“How could this be?” asked Gigerenzer. Eight accidents in ninety-four launches does convert into 99.6% certainty.
The guide replied Daimler Benz didn’t consider human failure in the calculation. The security calculation was based on the design features of the individual rocket parts.
This story echoes the probabilities that were banded around when the Space Shuttle exploded in 2003.
NASA engineers estimates the rate of failure for the shuttle at 145 (0.7%). Yet the program suffered two total write-offs in its first 113 launches. The Daimler-Benz and NASA calculations call into question how we relate uncertainty and risk to probability.
Michael J. Mauboussin, in a truly remarkable book, More than You Know (Columbia University Press, 2006) tells us we need to make the distinction between risk and uncertainty.
Risk is the probability of suffering harm or loss.
Uncertain is the condition of being uncertain; doubt.
Mouboussin argues “investing is fundamentally an exercise in probabilities” going on to say that “every day investors have to translate investment opportunities into probabilities”.
Successful negotiators have to do the same - except they have to translate deal opportunities into probabilities.
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