How to think about risk when there is extreme uncertainty?
Risk management under extreme uncertainty should be approaches by thinking about the balance between uncertainty and commitment. We think this way of thinking is more useful than the classical risk assessment frameworks.
This paper focuses specifically on making commitments and investments in high risk countries. These are countries with high levels of uncertainty, often with violence and armed conflict.
In this article we present some of the core ideas developed with our clients.
In this case, the intellectual roots of this article stem from researchers at the Uppsala University. A series of studies on business and internationalization emerged from that University in the late 1970s. (1) There have since been several iterations and contributions. These are empirical studies trying to understand business investment decisions under uncertainty. We stand on the shoulders of giants.
On the back of their contributions, we have developed frameworks for clients to help them manage investments and portfolios that are implemented in places with extreme levels of uncertainty – or risk.
This is an action oriented approach. The focus is on the types of actions that can be taken to reduce risk. More so than the typical probability/impact framework that offers little guidance for how to deal with the risks.
The core idea: Risk is a function of uncertainty and commitment
A fundamental idea is that risk is inherently about the relationship between uncertainty and commitment.
The more uncertainty, the lower the investment, for a given level of risk.
Or conversely, commitments can only be increased if uncertainty is reduced. The higher the commitment, the less uncertainty, for a given level of risk. High uncertainty=less commitment, low uncertainty=more commitment.
If your risk tolerance is increased, i.e the curve is shifted outward, you would then make higher investments with a given level of uncertainty.
Another key idea is that commitment decisions can be controlled internally, while managing uncertainty requires external action. Deciding whether to invest, and indeed the level of commitments, is a decision that can be largely controlled internally. At least more so than the uncertainty in the external environment.
The exhibit below illustrates the core concept.
Exhibit 1: Illustration of the risk function