The correct answer is C. random error.
The Fama-French three-factor model is a model that describes the cross-section of stock returns. It states that the excess return of a stock over the risk-free rate can be explained by three factors: market risk, size risk, and value risk.
The market risk premium is the additional return that investors demand for holding risky assets over risk-free assets. The size risk premium is the additional return that investors demand for holding small stocks over large stocks. The value risk premium is the additional return that investors demand for holding stocks with low book-to-market ratios over stocks with high book-to-market ratios.
Random error is the part of a stock’s return that cannot be explained by any of the factors in the Fama-French three-factor model. It is often referred to as “noise” or “unsystematic risk.”
Here is a brief explanation of each option:
- A. realized risk free rate: The realized risk free rate is the actual return that investors have earned on risk-free assets over a given period of time. It is often used as a proxy for the expected risk-free rate.
- B. rate of return on market: The rate of return on market is the average return of all stocks in the market over a given period of time. It is often used as a measure of the market risk premium.
- D. risk premium: The risk premium is the additional return that investors demand for holding risky assets over risk-free assets. It is often measured as the difference between the expected return of a risky asset and the expected return of a risk-free asset.