Additional Resources

  1. Greater Fool [econ411w14.lsa.umich.edu]
  2. Greater Fool Bubbles A Survel [phy.olemiss.edu]
  3. Economic Bubble [euler.math.uga.edu]
  4. Greater Fool Theory [euler.math.uga.edu]
  5. Dataspace: A Cultural Application Of The Greater Fools Theory: The ... [dataspace.princeton.edu]
  6. Bubbles [princeton.edu]

Definition

The greater fool theory states that the price of an object is determined not by its intrinsic value, but rather by irrational beliefs and expectations of market participants. A price can be justified by a rational buyer under the belief that another party is willing to pay an even higher price. In other words, one may pay a price that seems "foolishly" high because one may rationally have the expectation that the item can be resold to a "greater fool" later.

Greater Fool Theory

According to the Greater Fool Theory the price of an item is always determined not just by its intrinsic value, but also by the beliefs and expectations of the participants in the market. While these beliefs may be irrational in nature, they still play a major role when it comes to buying. For instance, the price of an object may be justified by a buyer who is rational simply under the belief that there could be another party who is willing to pay a much higher price for the same object then they are. In other words, at times, the consumer could justify buying something at an incredibly high price just because their rational mind has the expectations that the item can be resold to someone else who is willing to pay an even higher price, or a “greater fool.”

The Greater Fool - The Theory

According to the Greater Fool Theory, it is possible for a person to make money when purchasing securities whether they are overvalued or not and sell them later on at a profit. This is because of their belief that there is a great fool who will be willing to pay a higher price for whatever it is they have to offer. When someone acts under the influence of the Greater Fool Theory, they may end up investing in securities that are questionable without taking in to account other important factors such as quality. This is done hastily, in the hopes that they will be able to sell to another investor or Greater Fool who will also be hoping to flip the item quickly.

The downside to such a reasoning is that these speculative bubbles often burst, which results in a rapid depreciation in the value of the share price due to the selloff. The Greater Fool Theory applies in the stock market mostly where investors can be seen making questionable investments on a regular basis. But, that’s not the only area where this theory can be seen. Art is another commodity where speculation is supreme. It is where privileged access drive prices rather than the art’s intrinsic value. The Greater Fool Theory can also be applied to the real estate industry as well where people make investments with the expectations that the value of the property will rise.

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