The 8086 doesn't have virtual memory, so there is no such thing as a pagefault or invalid address. For a memory access, the microcode blocks until the bus interface circuitry completes the memory access. If there's physically nothing there, the memory access will either hang or come back with random garbage.
Don't believe there's an acknowledgement in the bus protocol. There's a RDY line with which a device can insert wait states before replying, and a HOLD that can be used for DMA from other devices. But there's no way for the CPU itself to detect the "there is physically nothing there" case. You indeed just get the arbitrary state of the data bus (the ISA bus was pull-up, I believe, so you'd get 1's on the data bus, which on the PC would then result in a parity error if the address was within RAM space).
(And yes, I'm still waiting with bated breath to see the teardown of the machine that implements this ridiculous bus.)
I was thinking the the READY line might cause problems. If nothing pulls it high, the memory access will be blocked forever. But I haven't looked much at how systems physically implement the bus, so maybe it defaults high.
I got curious and went to check the schematics. On the original PC, the READY input to the 8088 is the synchronized version of the RDY input to the 8284 clock generator chip (which probably explains why Ken and I were spelling it differently). This is generated by a latch delay circuit automatically based on the IOCHRDY signal on the 8 bit ISA bus (and some other local stuff on the board), which itself is an open collector line pulled high.
So indeed, if nothing does anything, #READY will go active automatically, simultaneously with the data lines (not!) being driven, and the CPU will sample junk.
Which is to say: IBM had to add a bunch of hardware to the board just to synthesize a default/ignore behavior for this line, which wouldn't have been necessary had Intel done it right the first time.
