The former Argentina international has become one of Europe's most respected coaches since taking over Atletico in December 2011 and had been linked with a high-profile summer move.
The Rojiblancos won the Europa League and the UEFA Super Cup in the first six months of his tenure and have enjoyed a superb Primera Division season this year.
The neighbours also meet in the final of the Copa Del Rey in May.
A statement on Atletico's official website read: "The club have reached an agreement that seals continuity and keeps the Atletico coach on the bench until 2017.
"Atletico Madrid and Diego Pablo Simeone have agreed to renew the coach for the next four seasons."