Professor Zipf goes to Wall Street
The heavy-tailed distribution of firm sizes first discovered by Zipf (1949) is one of the best established empirical facts in economics. We show that it has strong implications for asset pricing. Due to the concentration of the market portfolio when the distribution of the capitalization of firms is sufficiently heavy-tailed, an additional risk factor generically appears even for very large economies. Our two-factor model is as successful empirically as the three-factor Fama-French model.
The authors acknowledge helpful discussions and exchanges with Marco Avellaneda, Emanuele Bajo, Michael Brennan, Marc Chesney, Xavier Gabaix, Rajna Gibson, Mark Grinblatt, Mark Meerschaert, Vladilen Pisarenko, Richard Roll, Daniel Zajdenweber, William Ziemba and seminar participants at New York University, the University of Lyon, the University of Zurich, the 10th conference of the Swiss Society for Financial Market Research, the 24th international meeting of the French Finance Association and the 57th annual meeting of the Midwest Finance Association. All remaining errors are ours. The views expressed herein are those of the author(s) and do not necessarily reflect the views of the National Bureau of Economic Research.