The South Korean won experienced a dramatic sell-off on Tuesday, plunging over 4% at one point to record its largest single-day decline since 2010. The currency broke through the psychologically significant 1,500 level against the U.S. dollar, hitting its lowest point since the global financial crisis.

The sharp decline was triggered by heightened tensions surrounding Iran, which pressured risk assets and set off a Value at Risk (VaR) shock, leading to a vicious cycle of selling. A VaR shock occurs when market volatility exceeds investors' risk limits, forcing them to unwind positions even if their original investment thesis remains intact. This mechanism can trigger forced deleveraging and a cascade of liquidations, prompting indiscriminate asset sales to reduce risk exposure.

"Yesterday's VaR shock sparked widespread panic selling and indiscriminate position reduction," analyzed We Khoon Chong, a strategist at BNY Mellon in Hong Kong. Under the most pessimistic scenario, the won could weaken further toward 1,570 against the dollar.

Although the currency rebounded on Wednesday to around 1,480, continued foreign capital outflows from the stock market maintained pressure. Foreign investors net sold $3.5 billion worth of Korean stocks on Tuesday, followed by another $700 million in net outflows on Wednesday. This contributed to a roughly 12% weekly decline in South Korea's benchmark KOSPI index.

The Bank of Korea issued a statement emphasizing it would closely monitor whether the exchange rate and bond yields were deviating significantly from economic fundamentals, such as the current account balance.

The won has been on a rollercoaster ride recently. It previously strengthened amid a stock market rally but then weakened after South Korea pledged $350 billion in investments to the U.S. to avoid high tariffs. The Iran situation has now become the critical factor overwhelming bullish sentiment, with markets worried that rising oil prices will severely damage South Korea's trade balance.

The foreign exchange options market indicates traders see a 36% probability of the won reaching 1,550 by the end of June. Brendan McKenna, a strategist at Wells Fargo in New York, stated, "Our models suggest that if conditions worsen, the won could potentially fall to 1,600. Damaged market sentiment and persistently rising oil prices create a scenario where a further sharp decline is entirely possible."

On a more positive medium-term note, South Korea stands to benefit from the AI investment boom, offering a relatively optimistic outlook. Soaring demand for high-bandwidth memory and advanced chips is expected to boost export revenues. Yuxuan Tang, head of Asia macro strategy at J.P. Morgan Private Bank, believes the won could recover to the 1,400 level: "The won is highly correlated with the memory chip cycle, which is already fully reflected in the stock market but not yet priced into the currency."

However, some institutions remain pessimistic. Michael Brown, a strategist at Pepperstone Group Ltd. in Melbourne, noted, "The current market mindset towards fragile economies and assets is 'sell first, ask questions later.' The sharp fall in the KOSPI only adds fuel to the fire, and foreign capital continues to flow out."