The Greater Fool Theory

The Greater Fool Theory suggests it is worth paying a high price for an asset as long as it is to be expected that you can offload it to somebody who is willing to pay an even higher price later on.

The foundation that the theory is built on is the argument that market prices are not set by intrinsic values but by the beliefs and expectations of the market participants.

Keynesian Beauty Contest

In his work The General Theory of Employment, Interest and Money, published in 1936, the famed economist, John Maynard Keynes used an analogy of a beauty contest when trying to explain price fluctuations in equity markets.

However, in Keynes’ beauty contest, the participants are not trying to vote for the most handsome contestant, nor for the contestant that they think will be perceived as most handsome by the majority of the other voters, but for the contestant that they believe most participants will perceive as being seen as the most handsome one by other participants. 

Put into simpler terms: the market participants are not betting on the intrinsic value but on the expectations of the other participants.

 

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