Which of the following is a significant issue with CAPM?

The correct answer reflects a significant issue with the Capital Asset Pricing Model (CAPM) regarding its underlying assumptions about the distribution of asset returns. CAPM is based on the idea that investors hold diversified portfolios and seek to maximize expected returns relative to the risk taken, which is quantified by beta, a measure of an asset's sensitivity to market movements.

One of the key assumptions of CAPM is that asset returns are normally distributed. However, in reality, many financial asset returns exhibit non-normal characteristics, such as skewness and kurtosis. This discrepancy can lead to inaccurate estimations of risk and expected returns when applying CAPM in real-world scenarios.

The other options present issues that, while they could be relevant, do not represent the core criticism related to the statistical assumptions of CAPM. The model is not fundamentally designed to focus solely on short-term investments, it does not define multiple risk-free rates as it typically assumes a single risk-free rate throughout the investment horizon, and while it does assume rationality among investors, this condition is a common assumption in many financial theories, not limited to CAPM alone.

Therefore, the concern with the assumption of non-normal returns underlines a pivotal limitation of CAPM, emphasizing the challenges faced when applying this model