Essay: The Castle in the Air Theory

Sample Essay

The “castle in the air” theory originally formulated by John Maynard Keynes states that investors in general do no spend their time and energy in calculating the intrinsic value of a financial instrument, be it a stock, bond or other alternative investments. Instead, the real savvy investors, according to Keynes, prefer to spend time and energy in anticipating and analyzing how a “crowd of investors” will most possibly behave in the future.

The professional investor will try and anticipate what the crowd will do and if it seems that the crowd is optimistic and times are good, the crowd will tend to build “castles in the air”. The smart investor should try and buy before the optimism sets in so that he buys at a lower price than the general market.

The general idea regarding “firm foundations theory” in the mind of Keynes is that it is too time consuming and it is erroneous because it is not possible to accurately predict future performance by looking at past and current trends.

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