Long-Run Risk and Hidden Growth Persistence

An extensive literature has analyzed the implications of hidden shifts in the dividend growth rate. However, corresponding research on learning about growth persistence is completely lacking. Hidden persistence is a novel way to introduce long-run risk into standard business-cycle models of asset prices because it tightly intertwines the cyclical and long-run frequencies. Hidden persistence magnifies endogenous changes in the forecast variance of the long-run dividend growth rate despite homoscedastic consumption innovations. Not only does changing forecast variance make discrimination between protracted spells of anemic growth and brief business recessions difficult, it also endogenously induces additional variation in asset price discounts due to the preference for early uncertainty resolution.