The Portuguese Equity Risk Premium: What We Know and What We Don’t Know

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. The literature is reviewed to select techniques to overcome this difficulty, and estimates of equity risk premiums suited to the Portuguese market produced. Historical equity premiums are computed and the study finds what is believed to be a better understanding of the subject with the help of the Godfrey-Espinosa approach and of implied risk premiums. The Godfrey-Espinosa model is applied to a number of other European markets, and it is concluded that the Portuguese market implies a higher exposure to risk, namely when compared to other Euronext member markets. It is concluded 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.

Keywords: equity risk premium, Market integration, Euronext

JEL Classification: G12, G31