The 25-million pound project had roped in Knightley to play Cordelia, the youngest daughter of the King, who would have been portrayed by Sir Anthony Hopkins.
Gwyneth Paltrow as Regan, Lear's treacherous middle daughter, and Naomi Watts would have completed the cast as his eldest daughter, Goneril.
The film was expected to feature epic battle sequences.
It may be the first high profile casualty of the recession in the movie business, reports the Telegraph.
A spokeswoman for Ruby Films said: "Ruby are no longer doing it - the film will no longer go ahead. It has not really been announced."
Ruby Films refused to comment on whether the ongoing credit crunch was the reason for the film's cancellation. (ANI)