Yield Gap is a key indicator used by investors to understand the relationship between the returns from equity markets and government bonds. It helps in assessing whether the stock market is undervalued or overvalued compared to fixed-income securities. The concept plays a vital role in portfolio decision-making and long-term investment planning.

In simple terms, the Yield Gap is calculated by comparing the earnings yield of an equity index (such as the Nifty 50) with the yield of long-term government securities, typically 10-year bonds. The earnings yield is the inverse of the price-to-earnings (P/E) ratio, which shows the return an investor would get from stocks based on their current earnings.

When the yield gap is high—meaning the earnings yield is significantly above bond yields—it indicates that equities might be relatively cheaper and potentially offer better returns. Conversely, a narrow or negative yield gap suggests that equities could be overvalued or that bonds are offering more attractive, stable returns, leading investors to consider rebalancing their portfolios.

Monitoring the yield gap helps investors make data-driven decisions without relying on speculation. It is particularly useful during periods of economic uncertainty or changing interest rate cycles, as it reflects how investor sentiment shifts between riskier equity assets and safer fixed-income options.

However, the yield gap should not be used in isolation. Investors must consider other factors like inflation, earnings growth, and overall market sentiment. By integrating yield gap analysis with broader financial indicators, one can make more informed, balanced investment decisions aligned with SEBI’s principles of transparency and investor protection.