Decision Making under Uncertainty and Asset Allocation

Having to act in a context of uncertainty, or “take risks” is not something shocking and is at the centre of much of human endeavour. Sometimes risks are hard to quantify and certainly there are no quick fixes in deciding what to do; some are completely unanticipated. In other areas, including parts of finance, the underlying understanding of the context and the large aggregate experience of many players means much can be quantified. Understanding how to make decisions – even when you have full information about risks can be quite challenging. A bank needs to understand counterparty risk over a huge range of different potential scenarios if it is to understand its own risks and satisfy regulators. This raises massive computational tasks even if all the data is there. A pension fund needs to allocate resource to a number of different asset classes with very different return and investment profiles and match these to its own liabilities. 

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