Testing for random individual effects using recursive residuals

This paper derives a simple ANOVA-F-statistic which tests for random individual effects in a one-way error component model, using recursive residuals. Power comparisons are performed for this F-test when it is computed using true disturbances and recursive residuals from a panel data regression. Under the null, both statistics have an exact F distribution. The standardized version of the Breusch and Pagan (1980) Lagrange Multiplier test (SLM) as well as a fixed effects F-statistic (FE) recommended by Moulton and Randolph (1989), are also included in this comparison. The exact power function can be computed in all cases using Imhof's (1961) procedure. Our results suggest that the F-test based on recursive residuals is inferior to the popular SLM and FE tests based on computational simplicity, power comparisons and its sensitivity to the K observations starting the recursion.