The 26-year-old reunites with Watford manager, Marco Silva, who he worked with during their time together at Sporting Lisbon.
Carrillo joined Benfica last summer from rivals, Sporting, whom he signed for from Peruvian club side, Alianza Lima in 2011.
The winger played 24 matches for Benfica last season, helping them to the Portuguese treble in the process.
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Carrillo, who becomes the club’s eighth summer signing, has 35 international caps for his country, Peru.