The shares of the second-largest U.S. investment bank closed at $13.50, a penny above its intraday low.
Other large bank and brokerage stocks also fell, but not nearly as much. Chief rival Goldman Sachs Group Inc
Investors are still worried about Morgan Stanley's exposure to Europe and that's going to weigh on the stock, said Derek Pilecki, founder of Tampa, Florida-based Gator Capital Management, which operates long-short equity strategies in financial stocks. I think this will pass, but it may take some time.
Morgan Stanley shares hit their lowest since December 2008 last week after finance blog Zero Hedge reported the bank was at risk because of its exposure to French banks.
Morgan Stanley has zero net exposure to France, including French sovereign debt and French banks, a source familiar with the matter said on Friday.
Nonetheless, investors appeared to be reacting to fears in the credit markets related to Morgan Stanley.
The cost of insuring $10 million worth of the bank's five-year bonds against default spiked to $470,000 on Friday, almost three times what it was on June 30.
Morgan Stanley credit default swaps were more expensive than Italian banks Monte dei Peschi and Unicredit SpA
Morgan Stanley CDS are among the widest of its U.S. peers in CDS trading and significantly wider than French banks, said Casey. In part, it's hurt by perception because the markets are jittery.
A higher swap price indicates the market perceives a higher risk.
Credit default swaps are very thinly traded compared to equities, but many stock investors still view the product as an important measure of risk because they portended problems leading up to the financial crisis.
Walter Todd, a portfolio manager at Greenwood Capital whose fund holds 106,000 shares of Morgan Stanley, expressed frustration at the impact that credit default swaps appeared to have on Morgan Stanley shares.
There was no specific information to cause the stock to fall so sharply on Friday, he said, noting investors who do not own Morgan Stanley bonds can make speculative bets by buying credit default swaps, while also shorting its equity.
It's like seeing an overweight person walking down the street, buying a life insurance policy on him, then buying a gun and shooting him, said Todd.
Morgan Stanley's stock was down on Friday on heavy volume, with 51.3 million shares changing hands, 76 percent more than its 50-day average of 29.2 million shares. It was the fifth most actively traded stock on the New York Stock Exchange.
Morgan Stanley is likely to offer detailed information about its European exposure when it reports third-quarter results next month, analysts said, but other factors have also been weighing on large bank stocks.
Wall Street has cut its earnings expectations for large U.S. banks sharply through 2012 due to declining asset values, low interest rates and a weak business environment.
Analysts now expect Morgan Stanley to report third-quarter earnings per share of 36 cents, on average, according to Thomson Reuters I/B/E/S, down from 47 cents a month ago. They also cut estimates for the fourth quarter and for 2012 by 16 percent and 10 percent, respectively. Goldman has received even sharper estimate cuts.
(Reporting by Lauren Tara LaCapra; editing by Robert MacMillan and Andre Grenon)