Ibboton Chen Model

CFA Level II
#1

In the Ibboton Chen model, I do not understand how we use expected change in P/E ratio is directly related to the equity risk premium.

This then says that as the valuation on the asset decreases (with the decline in the P/E ratio) then the risk premium on the asset will also decrease. Are risk premium and asset value supposed to go in opposite directions?

#2

If something is potentially overvalued (high P/E), your required return would be high. If something is cheap (low P/E), your required return would be low. These are pseudo-explanations to help you remember the formula.