Risk and Uncertainty

What I don't like about Free Exchange is that I have no idea who the authors are who contribute to it. I don't know to always read and who to take with a grain of salt.

Here they note that modern finance "seeks to turn uncertainty into risk. You cannot quantify uncertainty, and you cannot trade it. It is pre-finance—and it can be corrosive. Risk, on the other hand, is a probability distribution. It is quantifiable. You can model it and analyse it and it has a value. Therefore, you can trade it." They are right on what modern finance seeks to do and the difference between uncertainty and risk. My problem lies with modern finance and actually turning uncertainty into risk.

I view uncertainty and risk from a Knightian lens. Risk is measurable, uncertainty is not: "The essential fact is that "risk" means in some cases a quantity susceptible of measurement, while at other times it is something distinctly not of this character; and there are far-reaching and crucial differences in the bearings of the phenomenon depending on which of the two is really present and operating. ... It will appear that a measurable uncertainty, or "risk" proper, as we shall use the term, is so far different from an unmeasurable one that it is not in effect an uncertainty at all. We ... accordingly restrict the term "uncertainty" to cases of the non-quantitive type."

So, that leads me to wonder can you actually convert uncertainty into risk or can you only reduce and spread out risk? Knight says that risk has an ex-ante probability distribution. In trying to get life insurance, from my perspective I have uncertainty because I cannot measure my risk, but the insurance company can and from their perspective it's a problem of risk. Subjectively, after I get insurance, I would know that after my death, my family would be taken care of. I would no longer have uncertainty (on this one part of the uncertainty of my death, there's a minimum of two others, like how and when), but the insurance company has gained a risk. Actually that may not be accurate. Maybe it is also uncertainty when it hits the balance sheet of the insurance company? Perhaps it is the subjective determination of the insurance company that makes it risk rather than uncertainty? This explanation seems lacking to me. A probability distribution seems outside of value and outside of the human mind. A more satisfying explanation, to me, is that the payouts on the insurance contract are uncertain by themselves for the individual and when transferred to the insurance company. They become risk when there are enough of them that produce a probability distribution.

As an example from modern finance, if you take a bunch of MBS and pool them into a CDO, you have certainly pooled them, but the pool of assets or the structure do not become a measureable probability distribution. So what you have with CDOs is not risk diversification, but taking a bunch of assets with uncertain payoffs, pooling them in a complex structure, and then sending different levels of uncertainty to people. Risk is not diversified, but different levels of uncertainty are spread out among the owners of the tranches to the CDO.