Abstract
I develop a sequential trading model with ambiguity-averse market makers and provide a theoretical explanation to the historical coincidence of ambiguous events, asset illiquidity, and price variability. My model implies that the bid-ask spread of an asset contains an additive component of ambiguity premium. As a result, higher ambiguity generally leads to lower asset liquidity. More interestingly, asset prices are variable under particular conditions: specifically, only mixed-strategy equilibria exist, such that market makers probabilistically set multiple prices. Further analyses confirm that the implication of price variability is robust to the modelling techniques of ambiguity.
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