Hi HaSmamit..
The second is arguably OK, but the first is subtly better for the following reason.
"The walls" is something specific that "my sister" paints on.
"Paper" is something general that "my sister" paints on.
So, in "on the walls," "on" is used to connect "paints" with something specific, whereas in "on paper," "on" is used to connect paints with something general. We could say that "on" has a relationship with "the walls" that's subtly different from the relationship between "on" and "paper." For that reason, it's a little better to repeat "on" before "paper" so that we have one "on" for each type of relationship.
That said, I doubt the GMAT would consider the second version incorrect. Who told you it's incorrect?