The Greater Fool Theory

“Technically, a market bubble is an economic event in which the prices of specific assets rise dramatically and increase beyond their fundamental value. In general, bubbles are viewed as outbursts of irrationality– self-generating and self-sustaining waves of optimism that drive up asset prices and cause investments to be misallocated. There is no general consensus among finance academics or practitioners as to what causes an asset bubble to form or what sustains the overvalued prices over the life of the bubble. However, one commonly discussed theory related to the continuation of a bubble is “The Greater Fool Theory.”

The Greater Fool Theory is the idea that, during a market bubble, one can make money by buying overvalued assets and selling them for a profit later, because it will always be possible to find someone who is willing to pay a higher price. An investor who subscribes to the Greater Fool Theory will buy potentially overvalued assets without any regard for their fundamental value. This speculative approach is predicated on the belief that you can make money by gambling on future asset prices and that you will always be able to find a “greater fool” who will be willing to pay more than you did. Unfortunately, when the bubble eventually bursts (which it always does), there is a large sell-off that causes a rapid decline in the asset values. During the sell-off, you can lose a great deal of money if you are the one left holding the asset and cannot find a buyer.”