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.