Greater Fool Theory

Greater fool theory refers to a mechanism of asset pricing under which the price of any asset is determined by what the buyers are willing to pay for the particular asset. It subjects the price to the emotional status of buyer than on the value of the asset. It is often blamed to be the cause of sudden growth of asset bubbles which are different from fundamental values. It occurs in case of stocks, real estate etc. where the practice that buyers justify the purchasing of an overpriced asset on the basis that they will soon be able to sell it at a higher price to other buyers.

Greater fool theory in Indian markets

The recent rise in penny stocks resulting in high indices in the bull market has to some extent been blamed on the greater fool theory. There is a number of shell or shady companies operating in the market out of which SEBI banned 300 companies. After several complaints being received from investors of SMSs from real estate companies to make investment, the SEBI has decided to crack upon these companies and put a ban on their operation.

The securities that they are trading in must be permitted only once in a month (first Monday of the month). They are not permitted to be traded at prices above the last traded price and an additional surveillance deposit of 200 per cent of trade value is to be taken from buyers for a period of five months as security. The companies’ credentials will also be verified by an independent auditor and if needs be by forensic audit.