During the long boom of the 1990s and up to 2007 it was therefore rational to assume that there would be a bail-out if such extreme events were to take place. This is called ‘moral hazard’ by economists: there was no incentive to write in extreme events to models, as such extreme events trigger government intervention that covers their risk. Therefore, the implicit underwriting of the bulk of risks in large financial institutions provides little incentive to create models that predict events that will be the subject of large government bail-outs.
