The Portuguese Equity Risk Premium

Abstract

Estimates of appropriate equity risk premiums are abundant in finance textbooks. Unfortunately, these estimates are ill suited to small and data scarce markets such as the Portuguese. We review the literature to select techniques to overcome this difficulty, and produce estimates of equity risk premiums suited to the Portuguese market. We compute historical equity premiums and find what we believe to be a better understanding of the subject with the help of the Godfrey-Espinosa approach and of implied risk premiums. We apply the Godfrey-Espinosa model to a number of other European markets, and conclude that the Portuguese market implies a higher exposure to risk, namely when compared to other Euronext member markets. We conclude that the valuation of Portuguese equities should carry a higher risk premium than the ones generally suggested in finance textbooks, and that the merger of the Lisbon Stock Exchange with Euronext should lead to a reduction in the appropriate risk premiums for Portuguese blue chips.