The scandal comes as Ozawa's Democrats were looking increasingly likely to win an election this year and end more than 50 years of nearly unbroken rule by Prime Minister Taro Aso's Liberal Democratic Party.
Investors are watching the political saga as paralysis in parliament has stalled government stimulus efforts to get Japan out of its worst recession since World War Two.
Political analysts have said the arrest of the aide on suspicion of accepting illegal corporate donations could prompt Ozawa to resign and upset predictions of an opposition victory in an election that must be held by October.
"I myself have done nothing of which to be ashamed and the actions of my secretary were carried out properly in accordance with the political funding law and properly dealt with," Ozawa told a news conference after party executives held an emergency meeting. "Therefore, it is not a matter of me doing this or that," he said when asked whether he would step down.
The Democrats are ahead in opinion polls amid rising voter frustration at policy inaction and flipflops by Aso. Aso, whose popular support has dropped below 10 per cent in one poll and is not much higher in others, is struggling to keep his own job and faces calls from within his party to step down before the election, which must be held by October.
Still, it was unclear how much Aso's beleaguered administration and the LDP would benefit from the opposition scandal, which could spread to ensnare ruling party lawmakers. "They receive money too. If they really go after the Democrats on this, their own problems may emerge. They're both the same, really," said Takahiko Murai, general manager of equities at Nozomi Securities.
Aso is Japan's third leader in less than two years. His two predecessors quit abruptly after their poll ratings sank in the face of a political stalemate caused by a divided parliament, where opposition parties control the upper house and can delay legislation and stymie policy. "This is not going to make Aso's ratings go up," political commentator Atsuo Ito said on a TV talk show.
Ozawa, a former LDP heavyweight who bolted the party in 1993 and helped to briefly oust it, has long struggled with competing images, one as a reformer intent on prying policy decisions out of the hands of bureaucrats and the other as an old-style backroom fixer with an autocratic management style. But his skills at campaign strategy and his ability to hold the sometimes fractious Democratic Party together have been seen by many analysts as important, if not vital, to its success.
WHAT DO YOU THINK? Should Ichiro Ozawa resign? Have your say by posting a comment below, or emailing us at firstname.lastname@example.org.