Frank Knight

We will choose a known okayness over a potentially amazing experience.

So one of the most important early writings on ambiguity aversion is a classic paper in the Quarterly Journal of Economics from nineteen sixty-one by the American economist, whistleblower, and political activist Daniel Ellsberg.

The paper was called Risk, Ambiguity, and the Savage Axioms.

Uh, that's Savage with a capital S. That's a person's name.

The question, uh, being addressed here is: How do people make those decisions when they don't actually know what the relative likelihood of different outcomes are? Uh, subjective expected utility theory has several rules, but a simplified version is that it says even when people don't know the objective likelihood of an outcome, they form beliefs about how likely that outcome is, and then they act consistently with those beliefs in order to maximize their personal benefit.

Hmm.

Uh, I came across a, a passage by the American economist Frank Knight, uh, which I think summarizes this idea well.

Knight writes, quote, "We must observe at the outset that when an individual instance, i.e., a one-time event, uh, only is at issue, there is no difference for conduct between a measurable risk and an unmeasurable uncertainty.

The uncertainty becomes background terrain.

That's the old distinction from Frank Knight.

Measurable risk versus what he calls Knightian uncertainty.

Exactly.

So he read apparently John Hicks' Value and Capital, Paul Samuelson's Foundations, a bit of Valhalla's Elements of Pure Economics, but also the kind of new stuff that was coming out of Princeton, John von Neumann and Oskar Morgenstern's Theory of Game.

I'm not sure what exactly he understood in that very abstract book in the early 50s, but he certainly got much from Frank Knight's Ethics of Competition.

And then in the 1950s, we know he read Luce and Rifa's Game and Decisions, which is a much more accessible book about game theory.

He also read Kenneth Arrow's Social Choice, Individual Values.

these big impact things that happen.

And they're sort of like Knightian uncertainty, Frank Knight had basically, when you didn't know the probability distribution.

And those kind of things can still happen, basically.

Like the crash of 87 was beyond what could reasonably happen from a probabilistic perspective.

It took me four years to write.

I found myself back in 1921 with a gentleman named Frank Knight, who was a...

Frank Knight was a professor at the University of Chicago, Chicago School of Economics, actually.

And he wrote a book in 1921 called Uncertainty, Risk, and Profit.

It's a totally

And when he comes back, he goes to the University of Chicago.

where he studies with Frank Knight, and I should point out a very young assistant professor, Milton Friedman, who teaches him one of his price theory courses as well.

He later goes on and wins a Nobel Prize in economics in 1986 for his development of the field of public choice and constitutional political economy.

And if I can, I just like to maybe drill a little bit into that and try to be as quick as I can.