“On the road from the City of Skepticism, I had to pass through the Valley of Ambiguity.” Adam Smith
Most of finance focuses on measurable risk. Less focus is uncertainty or events that cannot be give an objective probability of occurring. Those events that are hard to measure provide the greatest opportunity.
Even less time is spent on ambiguity which is not the same as uncertainty. An ambiguous decision situation may have more than one meaning or interpretation. Ambiguous events may have known probabilities but the decision-maker may have missing information. The model or analysis for these situations have doubt or cannot be fully measured. A Fed announcement may be ambiguous because it may have more than one meaning. This is different from an uncertain situation where the likelihoods are unknown. A recession model may be ambiguous because it does not have all the information necessary to make a judgment or similar models will provide different results.
“Risk is defined as a situation in which the event to be realized is a-priori unknown, but the odds of all possible events are perfectly known. Ambiguity refers to conditions in which not only is the event to be realized a-priori unknown, but the odds of events are also either not uniquely assigned or are unknown.” –Nabil I. Al-Najjar
An investment skeptic should look closely for ambiguity. Can there be more than one set of beliefs provide a rational narrative of a future event? If yes, then an investor should be skeptical of the story being told. Statements that are hard to interpret or verify with data should be looked at with a high degree of skepticism. For example, commentators who use ambiguous language should be viewed with a high degree of skepticism. We have talked before about the imprecision of language with respect to investment advice. If comments cannot be supported with data, don’t place a lot of weight on the statements.
Decision-making does not have to be focused on a yes or no conclusion. The skeptic can have a third choice – “I don’t know”. He will pass on a decision. Some may view that passing on a decision is a higher level of risk aversion, but we take a more practical view. The skeptic will form a decision feedback loop; not enough information, pass on a decision and go back and collect more information. Skepticism is good for investment work.