By definition, the risk premium corresponds to excess financial return, that is, it represents the difference between the risk of investing in the stock market and investing in risk-free assets. In the calculation of the risk premium, ICP - ANACOM has used international benchmarks, a practise which has been followed by several European regulators (see table 5).
|
Regulatory Body |
Methodology |
|
IBPT |
Historical databases + Teacher surveys + Regulatory precedents + Bottom-up database |
|
CMT |
Databasea: Ibboston Associates + DMS + Credit Suisse (HOLT) + Pablo Fernandez + Average of Investment banks. The median value was used. |
|
Arcep |
Historical database |
|
ComReg |
Dimson, E., Marsh, P. Staunton, M. (2006), Global Investment Returns Yearbook + Regulatory precedents |
|
Agcom |
Dimson, E., Marsh, P. Staunton, M. (2007), Global Investment Returns Yearbook |
|
Ofcom |
Dimson, E., Marsh, P. Staunton, M. (2010), Global Investment Returns Yearbook |
|
ERSE |
Survey to market agents - Pablo Fernandez, Javier Aguirreamalloa, Luis Corres, (2011) - IESE Business School - 6014 responses from 56 countries. In the Potuguese case, the survey had 33 valid responses. |
Source: Website of the respective regulators and BT report
Both in methodological and conceptual terms, the determination of the expected risk premium of the stock market is not a consensual task. In addition, the risk premium varies over time according to how investors perceive the risk of the asset in question and also according to their attitude towards risk, which makes it advisable to regularly update this variable.
Given that the risk premium is an extremely volatile variable, the focus should be put on observations based on longer data series, as supported by Damodaran in his study on this subject1, where it is referred that observations based on longer data series outweigh the benefit of more relevant observations associated with shorter and more recent periods, as the former provide for a smaller standard error. In this sense, the result tends to become more consistent as the period considered is lengthened.
Moreover, as mentioned in the determination of 2010, the current practice for estimating the market premium consists in the use of premiums made and observed over long historical series (25 to 100 years). However, this premium (calculated on the basis of ex-post data) may not correspond to the expectations of investors at the time the investment decision is made. After all, what matters is the opportunity cost of capital, which is only available and is only relevant at the time the investment decision is taken. This, in turn, requires that current market conditions, as well as future perspectives, are taken into account.
In this sense, as referred by BT, it is considered appropriate to use estimates based on future expectations (ex-ante), the calculation being based on Damodaran2 data and on studies by Pablo Fernandez, which are publicly available and deemed to be reference authors.
In the light of the above, and whereas: (i) the parameter must be updated on an annual basis, taking into consideration the methodology applicable as from 2012 (see point 2.1); (ii) not all databases used in the determination of 2010 are available, which makes the calculation not so transparent; (iii) the use of regulatory precedents is not very appropriate, given that many regulators use themselves the benchmark as methodology, it is deemed that Damodaran and Pablo Fernandez’s data should be used.
Methodology to be applied from 2012
The risk premium shall be calculated based on a simple average of ex-ante data - Pablo Fernandez and Damodaran (calculated in the year preceding that of the decision, taking future expectations into consideration), for Portugal.
1 Damodaran, Aswath, ''Equity Risk Premiums'', Stern School of Business.
2 Aswath Damodaranhttp://people.stern.nyu.edu/adamodar/.
