AOL shares dropped 8 1/8, to 64 12 on the New York Stock Exchange. Time Warner stock, which rocketed more than $25 a share on Monday, fell 7 1/8 to 85 1/8.

Overall, it was a down day on Wall Street, as rising bond yields pulled investors away from stocks.

The Dow Jones Industrial Average closed lower 61.12, to 11,511.08, while the Nasdaq composite fell 127.04 to 3922.63, just a day after enjoying its biggest-ever one-day point gain.

Yahoo, which reported higher-than-expected earnings after the bell Tuesday, led the Nasdaq lower, ending down 38 11/16, to 397 3/8, almost a 9 percent drop.

In after hours trading, shares of the Internet portal, which also announced a 2-for-1 stock split, dropped another 12 3/8 points.

Investors Trying to Digest AOL Deal

Analysts doubted that the drop of AOL and Time Warner meant investors had soured on their deal. Rather, they speculated that investors were trying to make sense of the complexities of the deal, and the fact that a flood of new shares would be issued as the top Internet service provider acquires a traditional and slower-growing media group.

"Yesterday there was a lot of excitement and enthusiasm and today I think people who hold AOL stock are realizing they are issuing an enormous amount of stock and some people may not be buying the concept and they're bailing out," said Steven Cohen, director of research at Kellner, DiLeo & Co.

Originally worth more than $160 billion when announced, the value of Time Warner's stock had declined sharply Tuesday. The deal calls for each of Time Warner's 1.5 billion shares to be exchanged for 1.5 shares of the newly created company to be called AOL Time Warner Inc.

Schroder & Co. analyst Arthur Newman cut his rating on AOL to outperform from significantly outperform, citing the prospect of a slowdown in the company's meteoric growth rate as it integrates Time Warner. He also set a 12- month price target on the stock at $85 a share, down from $105.

Meanwhile, Merrill Lynch analyst Henry Blodget estimated AOL could potentially fall to $55 a share, noting a high-end estimate of $90 to $100 in a year.

"Where the stock trades in this range, in our opinion, will be entirely a function of management's ability to instill confidence in the Street," he wrote in a note to clients.

Questions also remain about AOL's valuation. Previously, it had enjoyed the valuation of Internet companies. But with the merger, many are wondering whether it is technically still an Internet compnay, or whether it should be deemed a media company, or something in between.

Yahoo Beats Street

Meanwhile, Yahoo said it earned $57.5 million, or 19 cents per diluted share, in the fourth quarter, excluding certain unusual charges, compared with income of $12.9 million, or 4 cents per diluted share the year before.

The earnings beat the official consensus on Wall Street for a 15 cents per share profit, but the company came a penny short of meeting several industry analysts' so-called "whisper" number.

Yahoo's revenues totaled $201.1 million, compared with $91.3 million in last year's fourth quarter, and its December traffic averaged 465 million page views per day, compared with an average of 167 million the year before.

The company's number of unique users doubled to 120 million from 60 million a year ago.

— Reuters contributed to this report