Nikkei drops on profit-taking in volatile trade

Japan's Nikkei fell from a two-month peak on Friday, losing as much as 2.7 percent before paring losses as investors unwound long positions in the futures and cash market ahead of upper-house elections over the weekend.

Elsewhere, the rest of Asian stocks also reversed earlier gains. The Shanghai Composite eased over 1.5 percent, Australia's S&P ASX 200 index retreated further from the 5,000 mark and South Korean equities lost 0.2 percent.

Despite the day's volatility, the Nikkei was Asia's best-performing index with a 0.6 percent gain for the week while the Shanghai Composite is set to take last place, with a loss of 0.5 percent.

Wall Street's rally

A fresh record close on the Dow and S&P 500 overnight was unable to propel Asian shares higher. U.S shares were boosted by a batch of upbeat economic reports and after Fed Chairman Ben Bernanke reiterated that monetary policy would remain highly accommodative, even if the central bank starts to pare back its bond buying program.

Nikkei drops 1.5%

Japan's benchmark index was dragged down by 1.7 percent loss in market heavyweights Fast Retailing and Fanuc. Exporters also ignored a weaker yen, which hit a new seven-week low against the greenback around the 100.8 handle.

Traders attributed the sudden bout of volatility to profit-taking ahead of Sunday's election that sparked large scale selling of stock futures.

"The move down took a lot of people by surprise but what we've been worried about all week is that the level of optimism in the market is way too high," said Ben Collett, head of Asian equities at Sunrise Brokers.

The sell-off comes ahead of Sunday's election to the upper house of parliament. According to Reuters, opinion polls show Prime Minister Shinzo Abe's ruling coalition on track for a clear victory, which would strengthen his economic strategy known as "Abenomics."

(Read more: What Sunday's Japan election means for Abenomics)

"The markets are forward thinking. Let's assume he [Abe] wins a massive majority. What else have you got for markets in the month of August? Not a whole lot. This is a forward thinking move to say 'I've made my money this month so I'm out of here,' Collett added.

Sydney loses 0.4%

Australian stocks tracked the Nikkei's losses and retreated further from the 5,000 level, which it briefly crossed in early Asian trade. Resource stocks fell, even as as iron ore prices rose to $131.90 a tonne. Global miners BHP Billiton and Rio Tinto fell 1 percent each.

Oil and gas producer Santos lost 3.6 percent after reporting a 5 percent dip in second-quarter output and warned of a 3 percent reduction in 2013 production guidance.

The next barrier for the benchmark index to cross will be 5,012 points, which would mark a new a one-week high.

Shanghai down 1.5%

Gains on China's benchmark stock index were capped after a jump in the overnight money market rate fueled further speculation of another credit squeeze in the banking system. The one-day bond repurchase contract rose as high as 5.9 percent, but then soon fell back to normal levels by the morning.

(Read more: Albert Edwards: China deflation may be biggest risk to markets)

Real estate developers extended the previous day's sharp declines with China Merchants Property leading losses by 3.9 percent and Gemdale down 5 percent.

Kospi at 1,870

A 1 percent fall in some of South Korea's biggest stocks weighed on the benchmark index. Tech giant Samsung Electronics lost 1.5 percent while LG Display fell 1.3 percent following an initial 2 percent gain after reporting a 53 percent rise in quarterly profit on Thursday.

(Read more: If you think NSA is bad, look at South Korea)

Power stocks were in focus after the nuclear regulator announced that two nuclear reactors will be restarted this week, easing fears of power shortages during the summer months.

Korea Plant Serve and Engineering and KOPEC rose 0.7 percent each.

— By CNBC.com's Nyshka Chandran. Follow her on Twitter @NyshkaCNBC