Mr Yaalon, 62, a member of Mr Netanyahu's Likud party, spent the past four years in his inner circle of ministers, publicly backing his reluctance to give up the occupied West Bank and make way for a Palestinian state.
The former general has also supported the premier's threats to attack Iranian nuclear sites, although, behind closed doors, officials say he has urged Mr Netanyahu to give US-led diplomatic pressure on Tehran more time.
Mr Yaalon has argued that with the rise of Hamas in the other Palestinian territory of Gaza, and of kindred Islamists in neighbouring Egypt and Syria, the Jewish state is at risk and must focus on defence before diplomacy.
"At such a decisive time for the security of the State of Israel, when the region all around us is stormy, it is important to have a man who is rich in experience, like Moshe Yaalon, in this post," Mr Netanyahu said in a statement.
He nominated Mr Yaalon and other cabinet ministers two days after agreements were signed to form a new coalition government, which is expected to take office today.
Danny Danon, a Likud lawmaker considered especially hawkish on the Palestinians, got the deputy defence portfolio.
In a Facebook statement, Danon said he would "preserve the values of the nationalist camp", a likely reference to Israel's West Bank settlements, which the defence ministry oversees.