Persistent Crises and Levered Asset Prices.

This article develops a structural credit risk model that incorporates persistent macroeconomic crises and endogenous financial leverage to explain the joint dynamics of aggregate consumption, firms’ leverage ratios, and asset market risks during disasters. Unlike standard disaster risk models that treat disasters as instantaneous independent events and fail to capture observed increases in stock market volatility and credit spreads, this model features a regime-switching process for consumption and firm earnings, allowing crises to last multiple years with amplified leverage and risk premiums. The model is structurally estimated using data from S&P 100 firms (2004–2019), matching firm-level moments including leverage, stock returns, credit default swap (CDS) rates, and option-implied volatilities, and successfully replicates key features of the Great Depression and other crises without relying on crisis-period financial data. Key findings include the importance of countercyclical bankruptcy costs, the role of leverage in amplifying fundamental shocks and explaining the credit spread puzzle, and the sensitivity of equity option prices to default risk, highlighting the model’s ability to jointly capture equity, credit, and option market phenomena in a macro-finance framework.