The Italian, who left Swindon in February, will take charge from Monday morning and he replaces Martin O'Neill who was sacked on Saturday after the 1-0 defeat to Manchester United.
He becomes Sunderland's fifth boss in a little more than four years, and the first chairman Ellis Short has chosen since Niall Quinn's departure as chairman.
Short said: "Paolo is hugely enthused by the challenge that lies ahead of him. He is passionate, driven and raring to get started.
"The sole focus of everyone for the next seven games will be to ensure we gain enough points to maintain our top-flight status.
"I think that the chances of that are greatly increased with Paolo joining us.
"Our fans have shown tremendous patience and understanding this season.
"They have continued to back the team in huge numbers, both home and away, and that is something that continues to inspire all of us in our drive to give them the successful club they deserve.
"That remains our primary aim."
The Sunderland job is only Di Canio's second in management after his spell at Swindon and he was a big success in Wiltshire, guiding the Robins to promotion to League One.
Within seven games of the Premier League season left Sunderland are just one point above the relegation zone and Di Canio's first match will be at Chelsea.
Di Canio, 44, played for Lazio, Juventus, Napoli and AC Milan before making a move to Britain where he played for Celtic, Sheffield Wednesday, West Ham and Charlton.