Should I Stay or Should I Go? Trading Behavior Under Ambiguity

We provide new empirical evidence on investors' firm-level trading behavior in response to daily changes in stock ambiguity-Knightian uncertainty. The effect of ambiguity is distinct from and contrasts with the well-documented effect of risk, and shares a similar economic significance. An increase in ambiguity is associated with a subsequent reduction in stock and option trading and holdings, and is consistent with limited participation. A similar response is triggered by closest peers' ambiguity, suggesting information spillovers. Interestingly, an increase in ambiguity is associated with a subsequent increase in book-depth and a lower price impact, consistent with information inertia.