Answer: Investors have heterogeneous expectations.

## Explanation The correct answer is **C. Investors have heterogeneous expectations**. ### Why this is a limitation of CAPM: CAPM assumes that all investors have **homogeneous expectations** - meaning they all have the same information and form identical expectations about asset returns, variances, and covariances. This is one of the key assumptions of the CAPM model. **Why heterogeneous expectations are problematic for CAPM:** - When investors have different expectations about future returns, they will hold different portfolios - This violates the assumption that all investors hold the same market portfolio - The market portfolio may no longer be efficient for all investors - The linear relationship between expected return and beta may break down ### Analysis of other options: - **A. Investors have a single period investment horizon** - This is actually an **assumption** of CAPM, not a limitation. CAPM assumes a single-period investment horizon. - **B. The market is not transparent** - While market transparency issues exist, this is not a specific limitation of the CAPM framework itself. - **D. People need to pay a liquidity premium to do transaction** - This relates to liquidity risk, which is not directly addressed in the basic CAPM framework, but it's not one of the core theoretical limitations. ### Other key limitations of CAPM include: - Assumption of risk-free borrowing and lending - No taxes or transaction costs - All assets are perfectly divisible - All investors are price takers - All investors can borrow and lend at the risk-free rate Heterogeneous expectations is one of the most significant practical limitations of CAPM in real-world applications.

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