I'm grabbing some zip files from an S3 bucket and then converting them to gzip.  The zipped files are about 130 megs.  When uncompressed they are about 2 Gigs so I'm hitting the '[Errno 28] No space left on device' error.
Is it possible to use a different scratch space? maybe an EBS volume?
The accepted answer is no longer accurate due to at least two new AWS features added since the posting. There are many configuration options and costs to consider, but both would work for the OP's needs.

Lambda functions can now attach an Elastic File System (EFS) volume. Write to EFS instead of /tmp.
Lambda functions now let you configure the size of /tmp. Simply increase the size to handle your largest expected file.
Is there a way to change the 'scratch' (/tmp) space location of an AWS lambda function?