> How are financial people even calculating that kind of rarity? They don't properly, and that is the problem. A lot of it had to do with creating models that

> How are financial people even calculating that kind of rarity? They don't properly, and that is the problem. A lot of it had to do with creating models that do not reflect reality. They worked fine until extraordinary circumstances occur under which they break down. A well known mistake is assuming a normal distribution for financial returns. In reality this greatly underestimates the likelihood and magnitude of extreme moves that can cause catastrophic losses. Nassim Nicholas Taleb's book "The Black Swan" discusses this in great detail. The bottom line is essentially that a move more extreme than what you anticipated is going to happen eventually. LTCM made the mistake of neglecting the impact of changing correlations. The thought they had outsmarted the market by eliminating risk from their portfolio. But in times of financial turmoil, correlations of risky assets tend to increase. If your carefully constructed and hedged portfolio does not take this into account, you may be exposed to much more risk than you intended. This is precisely what happend to them. The fund was bailed out by a group of large banks, and their bets did eventually pay off, but the temporary losses were far beyond what their models had anticipated.