Worries over the euro zone's debt crisis hammered Asian stocks to their lowest in more than eight months and sent the euro down, struggling to stay above the previous day's four-year low as political divisions and fears of more market regulation kept investors on edge.

Japan's Nikkei average <.N225> closed at a new three-month low and the South Korean benchmark KOSPI <.KS11> fell to a near three month closing low, as investors worried about the troubles of Europe resulting in slowing growth there.

European markets rebounded from the previous day's slump, with the FTST Eurofirst 300 <.FTEU3> up 0.3 percent, Germany's DAX <.GDAXI> up 0.6 percent and France's CAC <.FCHI> half a percent higher.

The euro, reversed its earlier fragile rally, heading back to near four-year lows struck the previous day after Germany's surprise ban of naked short-selling in some securities spooked financial markets.

The euro fell 0.5 percent from late U.S. trade to $1.2348, having risen as far as $1.2433 on trading platform EBS in early deals, as traders covered short positions on speculation European monetary officials might move to check its rapid fall.

Germany's move to stamp out speculators added further worries to a market already jittery about Greece's heavy debts. Investors are fearing that austerity policies, needed to pull fiscally weak EU countries into line, will dampen European and world growth.

Berlin's unilateral step suggested Europe remained unable to form a united front in addressing its debt crisis. It worried investors by increasing uncertainty over market regulation.

Traders said Thursday's market slide appeared to be driven by sell signals from value-at-risk models, which are widely used by trading desks and funds to determine the level of risky positions they are willing to stomach.

The sharp drop in the Australian dollar against the yen and even the euro, and the euro's jump against the won, suggested that market players were being forced to cut positions across the board, even those bets against the single currency.

Many traders cited a lack of liquidity across markets as exacerbating the moves. They also noted heavy hedge fund selling across markets, including the Aussie and won.

The won, which logged its biggest weekly loss in more than 14 months, suffered in the broad sell-down of risky assets from value at risk models.

The yen, which usually gains during heightened uncertainty and risk aversion, rose against the high-yielding Australian dollar which slid 3 percent on the day pushing the unit down to a 10-month low.

Foreign selling was seen in many equity markets in the region and these sales are already hitting multi-month peaks.

Credit Suisse said in a report their foreign investors' selling in May for emerging Asia outside China and Malaysia is already the highest monthly aggregate since October 2008.

It said that if the pace of selling sustains for the rest of the month there could be net sales of $14 billion, compared with the high of $17.5 billion in August 2007, during the bear market.

We have seen a large amount of money come in and we are beginning to see some of that trickle out, said Bratin Sanyal, head of Asian equities at ING Asset Management in Hong Kong who manages $2.4 billion.

With global turmoil and growing risk aversion we are seeing some money being pulled out and flowing back into their home markets.

Asian stock markets continued to bleed for the second straight day and are heading toward its worst weekly performance since November 2008.

The MSCI index of Asia-Pacific shares outside of Japan <.MIAPJ0000PUS> fell 2.3 percent to a eight month low. It has now fallen 8.5 percent this week and 11.3 percent this year. Industrials <.MIAPJIN00PUS> and materials <.MIAPJMT00PUS> shares were the biggest losers.

The MSCI sector indexes for defensive sectors like healthcare <.MIAPJHC00PUS> and utilities <.MIAPJUT00PUS> posted modest losses, outperforming the broad market.

INSTABILITY TO STAY

Wall Street slipped on nervousness about the disarray in Europe and on worries the crisis would hurt growth. That came on the heels of losses in Europe for the third in four sessions.

Investors are entitled to be a little hesitant about putting a toe into the shark-filled waters, said Richard Morrow, director at E.L. & C. Baillieu Stockbroking. Only one thing is certain: this volatility is likely to stay around at least in the short term. This is a trader's market.

Australian shares gave up initial gains as Wall Street's drop weighed and worries remained that Europe's problems could hurt economic growth. The benchmark S&P/ASX 200 <.AXJO> was down 1 percent, wallowing at a 9-month low.

South Korean assets were dealt an extra blow by rising tensions in the Korean peninsula as Seoul exchanged tough rhetoric with its northern neighbor over the cause of a navy ship sinking that killed 46 sailors from the south.

Souring risk appetite also drove demand for safe haven U.S. Treasuries with the yield on the benchmark 10-year note easing to 3.35 percent after rising 2 bps the previous day on euro jitters.

ING's Sanyal said that aversion was a good omen for defensive sectors.

Some of the unloved sectors should do well. Telcos and utilities have performed poorly and are underowned. With the fear factor coming back into the market they should do well, he said.

(Additional reporting by Sonali Paul in MELBOURNE; Editing by Jan Dahinten)

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