- On Saturday, President Donald Trump warned of a potential "severe punishment" for Saudi Arabia.
- An official statement from the Saudi kingdom said it will reject any attempts to undermine its economy.
- After initially plunging 7% during Sunday trading, Saudi stocks pared losses to end 3.5% lower.
After nearly two hours of trade the index was down 7.0 percent, its biggest drop since December 2014, when oil prices were crashing. Shares in the region's biggest petrochemical producer, Saudi Basic Industries, tumbled 7.9 percent.
"It's the political environment. The market is reacting negatively to sentiment around the Khashoggi case and the political noise around it," said Salah Shamma, head of investment for the region at Franklin Templeton Emerging Markets Equity, a big global fund manager.
Shamma noted the fundamental situation of the Saudi economy had not so far been affected.
But regional traders said speculation the Khashoggi case might deter some inflows of foreign investment - and that a backlash in the U.S. Congress could lead to U.S. sanctions against some Saudi individuals - had triggered panic selling of stocks by some local investors.
"It seems that international accounts are punishing the Saudi exchange," a regional broker added.
Khashoggi, a prominent critic of Riyadh and a U.S. resident, disappeared on Oct. 2 after visiting the Saudi consulate in Istanbul. Turkey believes he was deliberately killed inside the building and his body removed. Riyadh has dismissed the claims.
U.S. President Donald Trump said on Saturday there would be "severe punishment" for Saudi Arabia if it turned out that Khashoggi was killed in the consulate.
Saudi Arabia said on Sunday it would retaliate to possible economic sanctions taken by other states over the case of Khashoggi, the state news agency SPA reported quoting an official source.
The kingdom will respond to any measure against it with bigger measures, the source said, adding: "The Saudi economy has vital and influential roles for the global economy."
The embassy in Washington later issued a tweet to clarify the statement. Saudi Arabia thanked countries including the United States "for refraining from jumping to conclusions" over the disappearance of Khashoggi.
@SaudiEmbassyUSA: To help clarify recently issued Saudi statement, the Kingdom of Saudi Arabia extends it appreciation to all, including the US administration, for refraining from jumping to conclusions on the ongoing investigation.
Britain, France and Germany called on the Saudi and Turkish authorities on Sunday to mount a "credible investigation" into the disappearance of Khashoggi, saying they were treating the incident with "the utmost seriousness."
"There needs to be a credible investigation to establish the truth about what happened, and - if relevant - to identify those bearing responsibility for the disappearance of Jamal Khashoggi, and ensure that they are held to account," foreign ministers from the three countries said in a joint statement.
Britain would have to think about the appropriate way to react if it was proven that Saudi Arabia was behind the disappearance of Khashoggi, foreign minister Jeremy Hunt said on Sunday.
"I don't want to get drawn into hypotheticals because we don't know the facts yet, but we have been very, very clear that if these stories are true, that would be totally appalling and we would have to think about the appropriate way to react in that situation," he told British television
Media companies and some technology executives have pulled out of a major Saudi investment conference scheduled for next week in Riyadh because of growing outrage over the disappearance.
Other stock markets in the Gulf opened higher on Sunday but began falling as Riyadh plunged, with the Dubai index sinking 1.4 percent.