Knockaert saw his 95th minute penalty, and subsequent follow up, saved by Manuel Almunia, before Watford broke away seconds later and Troy Deeney smashed home the winner to send the Hornets to Wembley.
Leicester had led 1-0 from the first leg and were twice pegged back during the game as Matej Vydra scored either side of David Nugent's header.
And for Pearson it was a devastating way to watch his side's promotion hopes go up in smoke.
"I can't imagine a worse way to lose," he said. "When you get a penalty you just hope he scores it - then what happened after that compounds the misery.
"Anthony is distraught as you would expect. I'm the first to admit it was a generous penalty decision. But to concede off the resulting penalty save is very hard to take.
"Unfortunately that's the nature of the beast."
He added on Leicester's website: "It's a cruel game. It's very difficult to put into words at the moment how the players, staff and supporters are feeling at he moment.
"It's a very cruel way to finish the game; from having the opportunity of winning the game to going out within a few seconds. That, I think, is an illustration of how tough it is to be successful.
"I think Watford were the better side on the day. In the second half we had to soak up a bit of pressure and we didn't manage the ball as well as we had done, but having said that we still had an opportunity at the end to win the game - unfortunately it's not gone our way."