Yield gap
Yield gap or yield ratio is the ratio of the dividend yield of an equity and the yield of a long-term government bond. Typically equities have a higher yield (as a percentage of the market price of the equity thus reflecting the higher risk of holding an equity.[1] [2]
The purpose of calculating the yield gap is to assess whether the equity is over or under priced as compared to bonds. For a given equity, the following cases may be considered:
- If the yield gap is numerically small, then equity yield is lower than bond yield implying that the equity is overpriced.
- If the yield gap is numerically large, then equity yield is higher than bond yield implying that the equity is cheap.