Prospect theory and a manager's decision to trade a blind principal bid basket

We analyze asset managers' decisions to execute substantial baskets of stocks. Such transactions can be executed in two ways. The first method is through blind auctions with unique features known as blind principal bids (BPBs). The manager learns the trading cost once the auction process determines the commission. The second method is to use an agency trade. In this case, the asset manager faces an actual trading cost that is unknown before execution due to market impact uncertainty. Using proprietary data, we investigate the manager's choice between BPBs and agency trade in a natural experiment with large monetary stakes. The volume traded in each sample basket is significant, which can amount to over 0.5% of the NYSE daily share volume. Our findings show that managers' behavior is more consistent with prospect theory than the expected utility framework. When asset managers trade BPB baskets, they are reluctant to realize the potential higher cost of agency trade and opt for the fixed cost of BPBs instead. Thus, our results complement the literature on the disposition effect by demonstrating that managers' trading cost decisions exhibit “play it safe” behavior.