We explore the implications of ambiguity|Knightian uncertainty|for the pricing of credit default swaps (CDS). A stylized model with heterogeneous investors predicts that the net exposure of the marginal investor determines the sign of the impact of ambiguity on the price of CDS contracts, because they are assets in zero-net-supply. Empirically, we fi nd strong evidence that the marginal investor is a net buyer of credit protection, as ambiguity has a negative impact on spreads. The economic signi ficance of ambiguity is similar to that of risk, given a six percent decrease in spreads for a one standard deviation change in ambiguity.

Keywords: Derivatives, Equilibrium, Heterogeneous Agents, Insurance, Risk aversion
JEL Classi fication: C65, D81, D83, G13, G22

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