Heuristic Methods for Updating Small World Representations in Strategic Situations of Knightian Uncertainty

Recent studies on the construction and use of "small world representations" in strategic decision-making under Knightian uncertainty say little about how such representations should be updated over the implementation phase. This paper draws on the psychology of reasoning to take a step toward answering this question. We begin by theorizing small world representations and how the scenario spaces they contain are constructed and may be updated over time. We then introduce two well-known heuristic methods of inquiry, disconfirmation and counterfactual reasoning; translate them into practical procedures for updating scenario spaces; and compare the relative performance of these procedures in strategic situations of Knightian uncertainty. Our principal findings are that the procedure based on counterfactual reasoning is superior to that based on disconfirmation with respect to (a) counteracting the confirmation bias, (b) promoting the exploration of the set of imaginable scenarios, and (c) facilitating action to mitigate or exploit the consequences of what would otherwise have been Black Swans. We close with some broader implications for the study of strategic decision-making under Knightian uncertainty.