Uncertainty and Speculation

Uncertainty is inability to forecast future event. Uncertainty means the position and momentum of a outcome cannot be simultaneously measured with arbitrarily high precision. Uncertainty hovers around every investment/lending. The longer the time duration the more uncertain will be the expected associated returns. So, how do investors/lenders cope with this situation? There are tools available to decide on deal, which involves uncertainties.

Uncertainty is more difficult to plan than risk. There are several tools and techniques available to deal uncertainty in project appraisal. Some of them are: payback period, sensitivity analysis, simulation and iteration. Though using these tools we cannot end up with precise outcome but at least we can limit amount of uncertainty surrounding investment.

Structures and methods of meeting uncertainty

The practical difference between the two categories, risk and uncertainty, is that in the former the distribution of the outcome in a group of instances is known (either through calculation a priori or from statistics of past experience), while in the case of uncertainty this is not true, the reason being in general that it is impossible to form a group of instances, because the situation dealt with is in a high degree unique. The best example of uncertainty is in connection with the exercise of judgment or the formation of those opinions as to the future course of events, which opinions (and not scientific knowledge) actually guide most of our conduct. Now if the distribution of the different possible outcomes in a group of instances is known, it is possible to get rid of any real uncertainty by the expedient of grouping or "consolidating" instances. But that it is possible does not necessarily mean that it will be done, and we must observe at the outset that when an individual instance only is at issue, there is no difference for conduct between a measurable risk and an unmeasurable uncertainty. The individual, as already observed, throws his estimate of the value of an opinion into the probability form of "a successes in b trials" (a/b being a proper fraction) and "feels" toward it as toward any other probability situation.

http://www.econlib.org/library/Knight/knRUP.html

Understanding risk, uncertainty and profit/cash-flows together is the best way to understand basic of financial studies. The essence of speculative behaviour is to balance of uncertainty and expected gain.

In general, speculation means forming opinion without knowing fact. Traditional theories suggested that speculation existed in forward market. Presently price of commodities surge and slump following the speculative behaviour of the investors in commodity market. The same way investment decision is affected by speculative behaviour of investors/lenders. Speculation further helps reduce amount of uncertainty involved in specific project. However provided unexpected result at times speculation can create financial hardship.