Uncertainty and Complexity

It is interesting, isn’t it, how we revisit things.

In 2007 I wrote my masters thesis on ‘real options’ (a form of financial valuation technique), arguing that it was a useful method for companies to gauge the value of utilising the Clean Development Mechanism (CDM) of the Kyoto Protocol. Real options thinking takes an unconventional view of uncertainty, proposing that rather than trying to quantify the extent of uncertainty in financial project analysis, an alternative is to describe the value of having options in the face of this uncertainty. These can then be described in a technical language and even quantified.   In fact, the greater the uncertainty, the more valuable options are.

This interest in dealing with uncertainty was rekindled as I bumped up against energy and economic modelling for climate mitigation policy. I offered to write a paper on uncertainty for the programme I was involved with, and was paired with a hard-core modeller who was experimenting with monte-carlo simulations. I was uneasy, and I couldn’t articulate why. (The paper itself somehow morphed into one on complexity thinking for climate mitigation policy two years later).

Today, having just submitted a paper to a complex systems conference in the UK, it came to me. My uneasiness was not so much with the tools, as it was with the paradigm. Modernist thinking dominates climate mitigation policy analysis, and within this paradigm uncertainty is something to be identified, quantified, contained. The emerging complexity paradigm proposes the opposite, articulated through the principle of ‘antifragility’. This principle holds that, apart from being a constant feature of complex systems, uncertainty is necessary and productive. Experimentation and innovation should be prized, a high failure rate can be a good thing.shipping_box_example

There is an echo of this in real options analysis – and I’m now intrigued to better understand the link.

4 thoughts on “Uncertainty and Complexity

  1. It sounds like real options in the case of climate change might just give decision makers/emitters more excuses to delay mitigation action though? Or maybe I’m not taking a high enough view, and you’re talking of real options regardless of what action might have been taken?

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  2. Your comment (inadvertently perhaps) touches on something I’m grappling with: what, if anything, is the role for emission reduction targets (something the mitigation policy community and others believe to be crucial from an environmental perspective) in complex social systems? Complexity thinking for public policy warns against centralised, quantified policy targets – they give the illusion of control but there is no true centralised control in a complex system, so lets give up on the illusion… Herein lies a separate blog post , clearly. I’ll get to work!

    Real options in the context of climate mitigation might be putting in the extra pipework on your geyser that enables you to connect to a solar panel in the anticipation of a future where electricity is prohibitively expensive for heating water. It will cost you a little now, but saves you the cost of a new system later. Technically, this is a ‘switching option’, you switch energy sources down the line. The one I explored in my masters was that of developing a waste-to-energy project as a CDM project in the anticipation that the carbon credits might actually be worth something in the future (option to delay). So I’m not really seeing real options as being about optionality relating to the extent of mitigation at an international / national policy level. Its more about how the complex system responds to the potential of these targets becoming reality.

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