Something surfaced in a recent book I read by Mervyn King (ex-BoE governor) called End of Alchemy — the relevant parts are about about the limits of risk management in central banking.

One of King’s central points is that  “risk” is actually fundamentally different than “uncertainty”.  Risk, when strictly defined, includes more/less quantifiable probabilities that you can “optimize” around.  That does sounds familiar.

But “uncertainty” (“Knightian uncertainty” is the technical term, it seems) is by definition unquantifiable – and the best you can do is “cope” with it.

King then shows pretty convincingly (and consistently with my own experience) that central bankers, securitization experts, rating agencies, etc. all thought they were modelling “risk” to a high level of precision in the lead-up to 2008 FC — but they really weren’t.  The probabilities were not remotely correct.

In hindsight, that seems pretty obvious — even 20 years of data is meaningless in context of modelling something so complex as human financial markets.  Maybe a million years would do?

So for complex economic processes, it’s better to “know that you don’t know” and assume “radical” uncertainty — and then set yourself up, not to model precise outcomes, but ways to cope when the SHTF, to be blunt.

It dawned on me that a lot of this applies to P3s when we talk about “risk transfer”.

Maybe that’s valid for some specific physical properties of an infrastructure asset component.

But for something as complex as toll road usage?  Not likely.  If this risk gets transferred in a P3, it’s not “optimizing” risk allocation but naked speculation — one side will win big, and one side will lose.  Or neither. Or both.

The better question in a P3 risk transfer is not “who might win?” but “who can cope with this better when the SHTF?”

It strikes me that some of the lessons apply to practical modelling of P3 value – and that maybe the real role of P3s for complex assets like infrastructure is less about transferring insurable risk (because there’s not much of that actually) and more about the ability of the private sector to “cope” with uncertainty more efficiently (which seems true and might be actually measurable).