Statisticians are very skillful in classifying the outcome of any event or happening into several possible states of nature. Text books call them as certainty, risk and uncertainty. But unfortunately we don’t find contemporary examples in the text book that deals with the current global economic situation which fall into these categories. This is an attempt to do that. This is a conversation between a student and his professor.
Student: Professor, I need a better understanding of these concepts. Can you help?
Professor: I will try. Let us start with certainty. This implies that all the outcomes will be known with certainty or with 100%. For example, every Indian citizen knows the Indian annual budget will always be in deficit. This is the same for the last several decades. This implies that the government will spend money that they don’t have by borrowing from the market. In India, even our exports are fitting into this picture. For the last 17 months, Indian exports have fallen significantly.
Student: Now I understand certainty. How can I use this information?
Professor: Yes, the value of Indian rupee will continuously get eroded against the dollar slowly over time. In the last five years, the value of it has dropped from 45 to 67 Rs. today. How can you use this information? You can take position in the NSE by buying dollar and selling rupee in the futures market. Let us now move on to risk. The text book defines it as the possible outcomes of an experiment are known but only with probability. The outcomes could be for example mutually exclusive and collectively exhaustive. This assumes that we know all possible outcomes and each of them stand alone precluding the other. For example the Chinese economy is slowing down and their foreign reserves are declining. To stem the situation China may do nothing or put currency control or devalue its currency. This is collectively exhaustive. All three possibilities are enumerated. The question now is what probabilities should we assign for each of these outcomes?
Student: I understand risk now and how do I use this information?
Professor: Any action taken by the Chinese government would result in the value of Chinese Yuan depreciating. They have run out of options. They lowered the interest rates six times last year to stop the economic decline with no success. Traders who have access to this information will buy US dollar by selling Chinese Yuan. Chinese devaluation will have an impact on Indian rupee as well. So you can buy the US dollar selling rupee in the Indian NSE.
Student: What about uncertainty?
Professor: This is a tough one. If the outcome of an event is uncertain that means we don’t know what are the possible outcomes more so with no knowledge of their probabilities. Brexit fits the bill. On June 23, 2016, the Britishers are going to the poll to decide as to whether, Britain should continue to be a member of the European Union. The association which existed for several decades may come to end. If it happened what are the possible outcomes? Will it really happen? If it did who gets to gain or lose? What types of disruptions will take place in their economic activities and so on. You see, too many possibilities not easily identifiable. This can be classified as uncertain event.
Student: What should one do under these circumstances?
Professor: Very hard to answer. First let the event take place. Yes vote will affect the value of both euro and sterling and of course their stock markets as well. We will wait see. OK.
Student: Thanks, Professor.
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