The addition of 8 mol% of Y2O3 to the ZrO2@mullite composites stabilizes the metastable tetragonal phase of ZrO2 in conventional and plasma‐sintered Y2O3‐stabilized ZrO2@mullite composites. A fused, highly dense, and interconnected microstructure is formed in the case of plasma‐sintered Y2O3 stabilized ZrO2@mullite composite. At 1 MHz frequency, the room temperature and tanδ of (10.37 and 2.06) is obtained for the conventional Y2O3 stabilized ZrO2@mullite composite and that of (38.8 and 4.02) is observed for the plasma sintered Y2O3 stabilized ZrO2@mullite composite. The substitution of Y3+ in place of Zr4+ creates sufficiently large oxygen vacancies at the grain boundary regions of these composites endowed mostly with the ZrO2 phase. In conventional Y2O3‐ ZrO2@mullite composites, both dielectric relaxation as well as conductivity relaxation are observed due to the dynamic motion of dipoles and relaxation due to the presence of defect states and porous structures. This leads to higher grain boundary conductivity than the grain conductivity of these composites. Thermally activated conduction mechanisms exhibited in these composite materials are projected from the complex impedance and modulus analysis. The conventional and plasma sintered Y2O3‐ ZrO2@mullite composite has an optical bandgap of 3.26 and 3.58 eV, respectively.