Government insurance, information, and asset prices

•This paper studies the impact of information quality and government policy on prices.•Information quality is shown to affect prices and cause excess volatility.•The possibility of government intervention during crises leads to an increase in prices.•Price indices' data from large, mid and small capitalization firms support the model.

An investment decision problem is studied, in a framework where the government offers insurance against the possibility of the price of a risky asset falling drastically. The problem is considered under different informational scenarios, i.e., information quality, under which agents have to infer the state of fundamentals of the economy. Changes in information quality is shown to affect equilibrium prices despite no concomitant changes in the fundamentals, creating excess volatility. The possibility of government intervention is shown to increase equilibrium prices, which can be ordered as a function of information quality. Empirical evidence supporting the model is presented.