The New Palgrave, Eatwell c.s. (1998:III:358), gives the current common view:
“The most fundamental distinction in this branch of economic theory, due tot Knight (1921), is that of risk versus uncertainty. A situation is said to involve risk if the randomness facing an economic agent can be expressed in terms of specific numerical probabilities (these probabilities may either be objectively specified as with lottery tickets, or else reflect the individual’s own subjective beliefs). On the other hand, situations where the agent cannot (or does not) assign actual probabilities to the alternative possible occurences are said to involve uncertainty.”
Indeed, most economic texts use this distinction in this manner (at least, up to now). However, I cannot disagree more. The objections to Knight’s concept are:
(a) Certainty and uncertainty are binary. So, if a situation is not uncertain, then we have certainty, and there is no assigning of probabilities.
(b) If I am uncertain about a situation and assign equal probabilities to all cases - the Laplace suggestion - then according to Knight this no longer is uncertainty!
(c) In Hornby’s definition, the distinction is not between known and unknown probabilities, but the distinction is between events and human thought.
Figure 41 contains a diagram of the objectionable use of terms 1921-2005.
Figure 41: A diagram of the current but objectionable use of terms
The diagram clarifies the inconsistency with the binary character of certainty/uncertainty, the curious treatment of “Laplace”, and the over-use of terms by introducing the term ‘risk’ where there already is the qualification that the probabilities are known.