What factors are included in the Fama-French three-factor model?

The Fama-French three-factor model introduces three key factors that are believed to explain stock returns better than the traditional Capital Asset Pricing Model (CAPM). These factors include:

1. Market Beta, which measures the sensitivity of a stock's returns to overall market returns. This factor accounts for the systematic risk of a stock relative to the market.

2. Size, often represented by the market capitalization of a company. The model posits that smaller companies tend to outperform larger ones on a risk-adjusted basis, reflecting the historical tendency of smaller firms to yield higher returns.

3. Book-to-Market Ratio, which compares a company's book value to its market value. The model suggests that stocks with high book-to-market ratios (value stocks) tend to outperform those with low book-to-market ratios (growth stocks), as value stocks may be undervalued relative to their fundamentals, offering greater long-term potential.

These components provide a more comprehensive understanding of asset returns by incorporating size and value factors alongside market risk, which are critical elements in the context of investment analysis and portfolio management. The other options do not appropriately capture the factors identified in the Fama-French model.