In economics, Knightian uncertainty is a lack of any quantifiable knowledge about some possible occurrence, as opposed to the presence of quantifiable risk. The concept acknowledges some fundamental degree of ignorance, a limit to knowledge, and an essential unpredictability of future events. Knightian uncertainty is named after University of Chicago economist Frank Knight, who distinguished risk and uncertainty in his 1921 work Risk, Uncertainty, and Profit: In this matter Knight's own views were widely shared by key economists in the 1920s and 1930s who played a key role distinguishing the effects of risk from uncertainty. They were particularly concerned with the different impact on human behavior as economic agents. Entrepreneurs invest for quantifiable risk and return; savers may mistrust potential future inflation. Whilst Frank Knight's seminal book elaborated the problem, his focus was on how uncertainty generates imperfect market structures and explains actual profits. Work on estimating and mitigating uncertainty was continued by G. L. S. Shackle who later followed up with Potential Surprise Theory. However, the concept is largely informal and there is no single best formal system of probability and belief to represent Knightian uncertainty. Economists and management scientists continue to look at practical methodologies for decision under different types of uncertainty.
The Ellsberg paradox is based on the difference between these two types of imperfect knowledge, and the problems it poses for utility theory – one is faced with an urn that contains 30 red balls and 60 balls that are either all yellow or all black, and one then draws a ball from the urn. This poses both uncertainty – whether the non-red balls are all yellow or all black – and probability – whether the ball is red or non-red, which is ⅓ vs. ⅔. Expressed preferences in choices faced with this situation reveal that people do not treat these types of imperfect knowledge the same. This difference in treatment is also termed "ambiguity aversion".
A black swan event, as analyzed by Nassim Nicholas Taleb, is an important and inherently unpredictable event that, once occurred, is rationalized with the benefit of hindsight. Historical developments like the widespread adoption of the personal computer, were entirely impossible to predict but nevertheless had world-changing effects. Another position of the black swan theory is that appropriate preparation for these events is frequently hindered by the pretense of knowledge of all the risks; in other words, Knightian uncertainty is presumed to not exist in day-to-day affairs, often with disastrous consequences. Taleb asserts that Knightian risk does not exist in the real world, and instead finds gradations of computable risk.
