Extreme Value Estimation for Heterogeneous Data

Abstract

We develop a universal econometric formulation of empirical power laws possibly driven by parameter heterogeneity. Our approach extends classical extreme value theory to specifying the tail behavior of the empirical distribution of a general dataset with possibly heterogeneous marginal distributions. We discuss several model examples that satisfy our conditions and demonstrate in simulations how heterogeneity may generate empirical power laws. We observe a cross-sectional power law for the U.S. stock losses and show that this tail behavior is largely driven by the heterogeneous volatilities of the individual assets.