What Is Unknown Unknowns?
Unknown unknowns represent risks or uncertainties that are entirely unanticipated because their existence is not even known. These are events or factors that fall outside an organization's or individual's current understanding, experience, or predictive models. They are distinguished from other categories of risk in that one cannot plan for them, as their very nature is unforeseen. The concept is a crucial element in advanced risk management frameworks, particularly within the broader field of portfolio theory, emphasizing the limitations of foresight and the need for resilience.
History and Origin
The phrase "unknown unknowns" gained widespread recognition through a statement made by then-United States Secretary of Defense Donald Rumsfeld at a news briefing on February 12, 2002. When discussing the lack of evidence of weapons of mass destruction in Iraq, Rumsfeld famously articulated a framework of knowledge: "Reports that say that something hasn't happened are always interesting to me, because as we know, there are known knowns; there are things we know we know. We also know there are known unknowns; that is to say we know there are some things we do not know. But there are also unknown unknowns—the ones we don't know we don't know."
10, 11While Rumsfeld's phrasing popularized the term, the underlying concept has roots in philosophical thought and fields like project management and intelligence analysis. The idea of unknown unknowns was also commonly used within NASA and referenced by Rumsfeld as having heard a variant of the phrase from NASA administrator William Graham.
Key Takeaways
- Unknown unknowns are risks or events whose existence is completely unexpected and unforeseen.
- They differ from known unknowns, where the existence of a risk is understood, even if its probability or impact is not.
- These events often carry massive impacts, fundamentally altering existing assumptions and plans.
- Effective preparation for unknown unknowns focuses on building resilience and adaptability, rather than specific prediction.
- The concept highlights the inherent limits of knowledge and forecasting in complex systems.
Interpreting the Unknown Unknowns
Interpreting unknown unknowns involves recognizing the inherent limits of analytical models and human foresight. Since these events are, by definition, beyond current comprehension, their "interpretation" shifts from prediction to developing systems robust enough to withstand shocks. This involves a focus on resilience rather than rigid planning. For instance, in financial markets, a robust investment strategy might prioritize holding diverse assets and maintaining an emergency fund to absorb unexpected downturns, rather than trying to predict the exact nature of the next crisis. The ability to identify potential vulnerabilities in existing systems, even without knowing the specific trigger, can be crucial.
Hypothetical Example
Consider a highly specialized technology startup whose business model relies on a rare earth mineral sourced from a single, politically stable country. The company's scenario planning might address known unknowns like supply chain disruptions due to natural disasters or labor strikes in that country. They might have a contingency plan for these events, perhaps by finding alternative suppliers or stockpiling inventory.
However, an unknown unknown might be the sudden discovery of a new, abundant, and synthetic substitute for that rare earth mineral by a competitor, making the natural mineral obsolete overnight and collapsing its value. This event was not considered because the possibility of such a synthetic breakthrough was not even on the company's radar. The core assumption of the mineral's irreplaceable nature was shattered by a technological advancement that was "unknown" to them and completely "unknown" in terms of its imminence and impact.
Practical Applications
The concept of unknown unknowns has profound implications across various sectors:
- Financial Markets: The 2008 global financial crisis, for example, contained elements of unknown unknowns for many participants, with the cascading failures of complex mortgage-backed securities and derivatives catching many off guard due to an underestimation of systemic interconnectedness. S9imilarly, the rapid and widespread economic disruption caused by the COVID-19 pandemic demonstrated how unforeseen global health crises could become major unknown unknowns, leading to unprecedented lockdowns and economic contractions. T7, 8he International Monetary Fund (IMF) highlighted the profound and uncertain economic impact of the "Great Lockdown," describing it as a crisis "unlike anything experienced in our lifetimes."
*6 Enterprise Risk Management: Corporations often employ stress testing and advanced risk assessment techniques to build resilience against a wide range of operational risk, strategic risk, and systemic risk, even those not specifically identifiable. - Government and Policy: Policymakers must account for unknown unknowns when developing national security strategies, public health responses, or economic stability measures. The emphasis shifts from predicting specific threats to fostering adaptive capacity and robust infrastructure.
Limitations and Criticisms
The primary limitation of addressing unknown unknowns is inherent in their definition: it is impossible to plan for something that is entirely unforeseen. Critics argue that focusing too heavily on "unknown unknowns" can lead to excessive caution or a paralysis of analysis, as one can always posit an unthought-of risk. Instead, a more pragmatic approach focuses on enhancing overall resilience and adaptability within systems.
Nassim Nicholas Taleb, in his widely influential book The Black Swan: The Impact of the Highly Improbable, elaborates on how certain highly improbable and unpredictable events—which he terms "Black Swans"—carry massive impact and are only rationally explicable in hindsight. These3, 4, 5 Black Swan events often embody the characteristics of unknown unknowns in financial markets and other complex systems. Taleb criticizes traditional market volatility models and due diligence practices for failing to account for these extreme, rare occurrences, often leading to a false sense of security.
While it is impossible to predict an unknown unknown, the goal is to create sufficiently flexible and diversified systems that can absorb shocks from a wide array of sources, whether anticipated or not.
Unknown Unknowns vs. Known Unknowns
The distinction between unknown unknowns and known unknowns is critical in risk management:
| Feature | Unknown Unknowns | Known Unknowns |
|---|---|---|
| Definition | Risks or uncertainties that one is not aware of and does not know exist. | Risks or uncertainties that one is aware of, but whose details, probability, or impact are unknown. |
| Awareness | No prior awareness of the risk. | Aware of the risk's existence. |
| Predictability | Unpredictable and unforeseeable. | Predictable in existence, but uncertain in specifics. |
| Examples | A sudden, unprecedented technological breakthrough or a truly novel global pandemic. | The outcome of a pending lawsuit, the exact timing of a recession, or future interest rate changes. |
| Mitigation | Build general resilience, adaptability, and redundancy within systems. | Gather more information, conduct more analysis, develop specific contingency plans. |
Known unknowns represent gaps in knowledge that can be reduced or eliminated through further research or data collection. For instance, in an investment portfolio, the specific impact of a potential interest rate hike might be a known unknown; while the hike itself is anticipated, its precise effect on various asset classes might not be quantifiable until it occurs. Unknown unknowns, conversely, represent risks that cannot be identified in advance because they are outside the current framework of understanding.
FAQs
Can unknown unknowns be predicted?
No, by definition, unknown unknowns cannot be predicted. They are events or risks that one does not even know to look for, as their nature is entirely outside existing knowledge or predictive models.
How do businesses prepare for unknown unknowns?
Businesses cannot prepare for specific unknown unknowns, but they can build general organizational resilience. This includes fostering adaptability, maintaining financial buffers, diversifying investments, developing robust business continuity plans, and cultivating a culture of flexibility and rapid response. The focus is on preparing for any shock, rather than a specific one.
Are "Black Swan events" the same as unknown unknowns?
Nassim Nicholas Taleb's concept of "Black Swan events" shares significant overlap with unknown unknowns. Black Swans are characterized by their extreme rarity, severe impact, and retrospective predictability (they seem obvious after they happen). Many events commonly cited as Black Swans, such as the 9/11 attacks or the 2008 financial crisis, fit the description of unknown unknowns in that they were largely unforeseen by most at the time.
1, 2Why is it important to consider unknown unknowns in finance?
Considering unknown unknowns in finance emphasizes the limitations of traditional risk models that rely on historical data and probabilistic forecasts. It highlights that portfolios need to be robust enough to withstand fundamentally new or unexpected market shocks, rather than just optimizing for known risks. This encourages greater portfolio diversification and a focus on capital preservation.