Internal versus external uncertainty - Making distinctions for decision-makers

There are different types or variants of uncertainty when describing investor decision-making. According to an old paper by Kahneman and Tversky, Variants of Uncertainty, action must be taken to reduce uncertainty, but we need to understand what kind of uncertainty we are facing. 

They describe two key types, internal and external. Internal uncertainty could be classified as ignorance while external uncertainty could be classified as disposition of an event. Internal uncertainty or ignorance refers to our inability to know the facts surrounding some event. We can, however, control internal uncertainty. We can get smarter or know the facts. Ignorance should always be minimized. We cannot control external uncertainty. This type of uncertainty is what will surprise us.

Uncertainty has a clear time component. Uncertainty about the past, what actually happened, is a form of ignorance. We can know the past and measure the chance of an event happening. We just may not know the facts. Uncertainty about the future is associated with external uncertainty. We can only project what we may think will happen in the future. 

External uncertainty can assessed through two ways. A distributional mode based on some distribution or range of chance and a probability, or a singular mode based on an assessed chance of an event happening. When we say that an event is likely to happen with some upper or lower bound, we are being distributional. We declare an amount of uncertainty. When we just say that an event is likely, we are being singular. These are important differences when we want to describe an uncertain event. 

By focusing on the type of uncertainty faced, investors can reduce or plan for ways to minimize uncertainty and thus better control risk.