Kebede's time of two hours four minutes and 38 seconds has only ever been bettered by current record holder Patrick Makau, and twice by previous holder Haile Gebrselassie. His run also smashed the course record of 2:05.39 set by Kenya's Moses Mosop last year.
Feyisa Lilesa came second, 14 seconds behind Kebede, in what was the fifth fastest run of all time, three seconds ahead of the Paul Tergat record which stood from 2003 to 2007.
Tilahun Regassa came third to complete Ethiopia's lockout of the podium places, with Kenyan runners filling the next four spots.
There was more Ethiopian glory in the women's race as Atsede Baysa won in a dramatic photo finish against Rita Jeptoo of Kenya.
Both athletes initially recorded a time of 2:22.04, but Baysa was given the decision and later had her time rounded down to 2:22.03.
Kenya's Lucy Kabuu was third while Russia's Liliya Shobukhova was fourth after bidding for an unprecedented fourth straight victory in the race, one of the five World Marathon Majors.
The cool conditions were perfect for fast running as the elite runners led the massive field of around 45,000 entrants along the Chicago lakefront and through the city's neighbourhoods.
Kebede won the London Marathon two years ago and almost won Chicago as well but was run down in the last 400m by the late Samuel Wanjiru.
"I don't believe it," Kebede said.
"This has been my goal, 2:04, so I just pushed and pushed and pushed."
1. Tsegaye Kebede (Ethiopia) 2:04:38
2. Feyisa Lilesa (Ethiopia) 2:04:52
3. Tilahun Regassa (Ethiopia) 2:05:27
4. Sammy Kitwara (Kenya) 2:05:54
5. Wesley Korir (Kenya) 2:06:13
6. Bernard Kipyego (Kenya) 2:06:40
7. Samuel Ndungu (Kenya) 2:07:26
8. Dadi Yami (Ethiopia) 2:07:43
9. Dathan Ritzenhein (U.S.) 2:07:47
10. Abdullah Dawit Shami (Ethiopia) 2:08:39
1. Atsede Baysa (Ethiopia) 2:22:03
2. Rita Jeptoo (Kenya) 2:22:04
3. Lucy Wangui (Kenya) 2:22:41
4. Liliya Shobukhova (Russia) 2:22:59
5. Caroline Rotich (Kenya) 2:23:22
6. Mariya Konovalova (Russia) 2:25:38
7. Fatuma Sado (Ethiopia) 2:26:09
8. Renee Metivier Baillie (U.S.) 2:27:17
9. Dorothy McMahan (U.S.) 2:32:11
10. Stephanie Pezzullo (U.S.) 2:32:42