World stocks hit 2-1/2 month lows on Tuesday and oil fell and the yen surged after reports of rising radiation near Tokyo triggered a 10 percent fall in Japanese stocks, hurting risky assets across the board.

German government bonds and the low-yielding dollar were the biggest beneficiaries of increased risk aversion while a measure of European equity volatility surged to an 8-1/2 month high.

Tokyo stocks fell 14 percent at one point before posting their worst two-day losing streak since 1987 after Japan said the risk of nuclear contamination was rising.

Japanese bond yields rose as investors sold debt to offset equity losses and concerns rose the country, already saddled with public debt double the size of its gross economic output, may issue even more government bonds to fund quake relief.

The market will do its best to price in the worst case scenario and we will move forward from there. But the situation is very fluid and changing from hour to hour, said Keith Bowman, equity analyst at Hargreaves Lansdown.

The Japanese funds have a considerable amount of foreign debt and there are concerns that events may cause them to sell some of their debt and repatriate the funds back home. The MSCI world equity index <.MIWD00000PUS> fell 2 percent, hitting its lowest since mid-December. The index has erased all of this year's gains, and is now down 0.7 percent since January.

The Thomson Reuters global stock index <.TRXFLDGLPU> fell 2.1 percent. The Nikkei 225 index fell 10.6 percent while the broader TOPIX index fell 16.3 percent this week, the worst two-day losing streak since October 1987.

The downside is completely open-ended at the moment as headlines come through, said Roland Randall, strategist at TD Securities in Singapore.

The FTSEurofirst 300 index <.FTEU3> fell 2.7 percent while emerging stocks <.MSCIEF> were down 2 percent.

The VDAX-NEW volatility index <.V1XI>, one of Europe's main barometers of anxiety, surged 18 percent on Tuesday, hitting its highest level in 8-1/2 months.

The higher the volatility index, based on sell- and buy-options on Frankfurt's top-30 stocks, the lower investors' appetite for risky assets such as stocks.

In Asia, U.S. stock futures slid nearly 3 percent at one point, while safe-haven U.S. Treasuries soared, with 10-year Treasuries climbing more than a full point earlier. Moves of such a degree in Asian hours are rare in those markets.

U.S. crude oil fell 1.9 percent to $99.30 a barrel.

BUNDS, DOLLAR BENEFIT

The bund future rose 67 ticks. Japan's benchmark 10-year yields rose by one basis point to 1.215 percent.

Japan's five-year credit default swaps, which gauge the cost of insuring the country's debt against default, jumped 28 basis points from the close to a record high of 122 basis points.

The dollar <.DXY> rose 0.5 percent against a basket of major currencies, pulling away from last week's four-month low, while the yen rose across the board.

The Australian dollar fell 1.2 percent to 81.37 yen and the euro slipped 0.4 percent to 113.75 yen.

The Japanese currency was steady at 81.50 per dollar, with Japanese repatriation flows balancing selling by foreign investors who sold the stock market.

The Bank of Japan stepped in to keep the banking system stable for a second day, offering $98 billion of cash if needed. It lined up a record $183 billion in same-day funds on Monday and doubled an asset-buying scheme to support prices.

The BOJ said on Monday it would double the size of its asset purchase to 10 trillion yen ($122 billion).

(Additional reporting by Atul Prakash; Editing by Catherine Evans)

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