Consider the model Y i 1 2 X 2i u i (1) To find out whether this model is mis specified because it omits the variable X 3 from the model, you decide to regress the residuals obtained from model (1) on the variable X 3 only (There is an intercept in this regression ) The Lagrange multiplier (LM) test, however, requires you to regress the residuals from model (1) on both X 2 and X 3 and a constant Why is your procedure likely to be inappropriate

Question: Consider the model Y i = 1 + 2 X 2i + u i .. (1) To find out whether this model is

Consider the model

Y_i = β₁ + β₂X_2i + u_i…………….. (1)

To find out whether this model is mis-specified because it omits the variable X₃ from the model, you decide to regress the residuals obtained from model (1) on the variable X₃ only. (There is an intercept in this regression.) The Lagrange multiplier (LM) test, however, requires you to regress the residuals from model (1) on both X₂ and X₃ and a constant. Why is your procedure likely to be inappropriate?

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