Romanian – American University, Bucharest
As a result of economic development in these last centuries, international financial deposits have underwent a great transformation for the better especially in the second half of the twentieth century. The higher degree of integration of the international financial markets leaves it’s footprint upon the international financial flows and their coming and goings.
Financial globalization is an irreversible process that subjects the whole ensemble of world economics to structural and functional modifications.
The implication of some activities in the financial domain but especially in the stock market can be unforeseen and lacking in control. Therefore, a crash at one of the more important Stock Exchanges has immediate repercussions on all stock market, due to the extraordinary speed of information sharing in this domain.
In these present conditions, the understanding of the mechanism in which financial markets behave, their specific instruments, an in depth analysis of the risk that investors subject themselves, the inclusion of this variable in decision making and taking all necessary precautions to diminish these risks, represent the basis for economic development and general progress.
Despite the fact that there is a vast amount of works concerning risk and uncertainty in decision-making, the approach of these complexes categories in economics is relatively recent.
The attempt to formal risk analysis and their economic effects, has been an under tailing that has begun with neoclassic economists such as Daniel Bernoulli, William Stanley Jevons, Carl Menger, Francis Y. Edgeworth, through the introduction of a new concept named marginal utility in all risky decisions making.
THE PROBABILITY APPROACH OF RISK AND UNCERTAINTY
The first serious theoretic analysis of risk was undertaken by Frank K. Knight in 1921, in its work titled „Risk, incertitude and profit”. In Knight’s vision1 „risk is characteristic to that decision making situation in which the decision maker can associate a mathematic probability to a chain (succession) of events, uncertainty being, implicitly, that situation in which the development (evolution) of events cannot be expressed under the form of a theorem or a probabilistic equation”.
Obviously this separation of the two decisions making situations was later contested by a series of theorists claiming that in Knight’s approach, uncertainty and risk are one and the same.
The capacity to associate to a more or less random evolution of events a relevant probability, actually transforms risk and uncertainty analysis not into a matter of identifying their existence but into a matter of identifying the relevance of theorems and game theory equations that can be associated with that chain of events (as a result we can see here a one-sided / biased note in the appreciation of risky or uncertain situations).
Knight’s approach cannot be used to determine the risk level in a decision making situation, being difficult enough to appreciate the measure in which we can associate or not the probability of a chain of events or their degree of relevance in game theory equations. Further more2, probability that a decision maker associates to a given situation it’s given by his ability to interpret the evolution of the chain of events that he analysis.
Probability is therefore a biased expression of the interpretation of a chain (series) of events and is less connected with the random evolution of the economic phenomena that surround us. There can be situations considered risky by some annalists and other can deem them uncertain (the individual level of the observer can affect the quality of one’s analysis).
Knight’s approach cannot draw a finite line between risk and uncertainty and as he (Knight) defined risk most decision-making situation appear to be uncertain.
Despite all criticisms to Knight’s approach, his separation of risk and uncertainty represents a crucial moment in risk theory.
Uncertainty, in accordance with Knight’s definition, is the expression of the random evolution of some economic phenomena and more than that, for their analysis the decision maker has a limited amount of time and information3. Therefore we can see that the situations encountered are new, lacking in a precedent and unable to be associated with a relevant probability.
Practically, the risk characterizes only those situations in which scenarios can be built given certain data and for which alternatives can be determined precisely and are clear for the decision maker.
Economic decision-making is based upon two variables: information accuracy (the data that the decision maker holds is perfect and available for him at any moment) and prediction exactness (the risk making event will occur in the future exactly as it has been prophesied at a previous moment).
Seldom is economic reality characterized by perfection, sources of information being often distorted through the accuracy and freshness of data, the real state of events or on the contrary the unforeseen events can prove null initial predictions.
The foundation of classical decision-making theories, based on certainty, is slowly being eroded by real life situations that do not correspond to complete and full knowledge requirements of all conditions and effects for the making of an event.
As a direct consequence of this fact, modern decision-making theory doesn’t operate with absolute certainties, with precise estimations of the evolution of a certain element or phenomena but the decision makers often use uncertain and probable estimations concerning notions like risk and uncertainty4.
Most decisions are taken in conditions of risk and/or uncertainty, the incomplete knowledge of one or more “variables” becoming the status quo of international investment activity.
CERTAINTY, RISK OR UNCERTAINTY IN
INTERNATIONAL PORTOFOLIOS
Constantly searching the most attractive gaining opportunities, international financial deposits/portfolios have undergone an unprecedented development. This evolution, was not at all surprising if we were to look through the eye of the international capital markets that are more and more integrated or at the rapid means of data transfer, has induced a permanent preoccupation for the analysis of the main variables taken into consideration for the portfolio decision, in which the risk is indubitably the most important factor.
In this context, we can acknowledge that the supposition of certainty in decision-making is gradually being eroded by real life situations (complex and unpredictable) that do not correspond to the demands of correct and full knowledge of all effects and conditions required for the occurrence of an event.
As a direct consequence of this, the modern decision making theory doesn’t operate with absolute certainties, precise estimations regarding the evolution of a certain event or phenomena anymore, decision makers are using more and more an uncertain and probable estimation when it comes to notions like risk and uncertainty.
You can easily state that in most decision making situations that the controllers are faced with regarding the use of a financial deposit on the international markets are either risky or uncertain.
This conclusion is based upon a series of abnormalities (tied to the quality and freedom of data regarding markets, instruments and participants, the lack of common rules and regulations in the matter of transactions or access privileges for a market, the high degree of concentration of the financial market, different behavior of economic controllers when it comes to using the financial markets for attracting capital resources etc.) still present in the international financial system that drastically diminishes the degree of certainty in decision making.
Each of the three decision making situations - certainty, risk and uncertainty - is usually defined in relation with the other two. Such an approach makes for a better segregation of the exact sphere in which each concept is defined and its positioning relation with the others.
Depending on the degree of knowledge regarding the future evolution and effects of a certain event, the three concepts can be defined in this way: at extremes, certainty and uncertainty, while risk can be placed in an intermediate position.
Any international financial deposit implies a “selection” process consisting in many alternatives that will later produce different results (negative or positive).
For the result that comes out of the taking a decision to be as close as possible to the desire/objective of the decision maker it is necessary to reduce as much as possible the uncertainty in connection with the possible consequences of the decision and the factors capable of modifying the evolution of an anticipated or wanted action. All this considered, in what concerns the area of international capital deposits, regardless of the precautions and guaranties that might be obtained/ resorted, there will always be a “marginal adjustment” so that the level of the activity’s complexity and that of the decision rises, exponentially the margin of unpredictability and therefore uncertainty grows.
The definition that Wiliams gave, stating that uncertainty represents the “impossibility of predicting which of the possible results of a decision will occur”, bring closer the meaning of the term uncertainty to that of the term risk and “binds” these two concepts, this of course implying the consciences ness by the decision maker of the existence of some risks connected with the possibility (that it is not quantifiable under the shape of an associated probability but only summary identified) of interference in the development of an international activity regarding some factors (situated outside the decision makers zone/sphere of control) of a nature capable of conferring an unwanted course of action.
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