What is a key issue with the Yardini model?

The Yardini model is a valuation model that aims to provide insights into the equity risk premium by correlating it with interest rates and expected earnings growth. One key issue with this model is that the risk premium it calculates is largely driven by default risk rather than the equity risk premium in isolation. The model often takes into account current interest rates, which can reflect the risks associated with default on corporate bonds, rather than purely focusing on the risk associated with equities.

This reliance on default risk can lead to misleading conclusions about the true equity market risk premium, as it conflates different types of risk and may not accurately represent the investor's required return for holding stocks as opposed to bonds. It can obscure the actual risk factors that equity investors may face, particularly in volatile markets or during periods of economic downturn.

Understanding this issue underscores the importance of distinguishing between different types of risk when evaluating equity investments and the limitations of models that may not adequately separate these complexities.