The Equity Risk Premium Across European Markets: An Analysis Using the Implied Cost of Capital

Abstract

Using a large data set of companies from 16 European countries over the period between January 1994 and May 2011, we estimate the equity risk premiums applying an implied cost of capital approach. We find estimates that are consistently larger than those in previous studies, ranging from 4.4% to 6.9% across countries. Our main conclusion is that a positive trend over our sample period is responsible for the high estimates in comparison to previous studies. The trend is accompanied by declining risk-free rates over our estimation period, suggesting a much greater stability in the absolute return on equity than often assumed by classical asset pricing models.

Keywords: time-varying risk premia, equity premium, implied cost of capital

JEL Classification: G12