Abstract
Rietz(1988)andBarro(2006) subject consumption and dividends to raredisasters in thegrowth rate. We extend their framework and subject consumption and dividends to rare disasters in the growth persistence.Wemodelgrowth persistence by means of twohiddentypes of economic slowdowns: recessions and lost decades.
We estimate the model based on the post-war U.S.data using maximum likelihood and find that it can simultaneously match a wide array of dynamic pricing phenomena in the equity and bond markets.The key intuition for our results stems from the inability to discriminate between the short and the long recessions ex ante.