Mitsubishi UFJ Financial Group Inc. led declines by financial companies. Exporters including Toyota Motor Corp. dropped after economic data pointed to slower growth in the U.S., indicating the housing market recession is spreading to other parts of the economy.
Shares also fell after Pakistani opposition leader Benazir Bhutto was assassinated, threatening stability on the Indian sub-continent.
The Nikkei 225 Stock Average slid 256.91, or 1.7 percent, to 15,307.78 at the 11 a.m. close of trading in Tokyo. The broader Topix index slumped 24.26, or 1.6 percent, to 1,475.68.
Today is the last trading day of the year and the Tokyo Stock Exchange closed after the two-hour morning session. The Nikkei dropped 11 percent in 2007, its first annual loss in five years. The Topix tumbled 12 percent, making Japan the worst performer among the world's 10 largest markets.