The coveted honour is in recognition of the role played by the reformist leader in ending two decades of bloody and costly conflict with neighbouring Eritrea.
In a statement issued following the announcement, the Ethiopian prime minister’s office tweeted: “We are proud as a nation.”
Mr Ahmed had been the bookmakers’ second favourite to win the prize, after 16-year-old Swedish climate activist Greta Thunberg.
Berit Reiss-Andersen, chairwoman of the five-member Norwegian Nobel Institute that awards the prize, said Mr Ahmed was recognised for his efforts to achieve peace and international co-operation, and in particular “for his decisive initiative to resolve the border conflict with neighbouring Eritrea”.
She also said Mr Ahmed had initiated important reforms that give many citizens in his country “hope for a better life and a brighter future”.
His efforts deserve recognition, she said, and it is hoped the awarding of the peace prize will strengthen Mr Ahmed’s position “in his important work for peace and reconciliation”.
Ethiopia and Eritrea fought a border war from 1998 to 2000 and only restored relations in July 2018 after years of hostility.
Mr Ahmed, who became prime minister in April last year, has earned further praise for helping to secure a power-sharing agreement in Sudan, following a political crisis that led to the arrest of the country’s long-time ruler Omar al Bashir.
Five facts you need to know about Abiy Ahmed
- The fitness fanatic defused a protest in October 2018 by armed soldiers who stormed into his office demanding a pay rise by ordering them to do 10 press-ups – and joined them
- On 2 April 2018, then 41, he became Africa’s youngest leader when he became Ethiopia’s PM
- He comes from a mixed cultural background: his father was Muslim and his mother a Christian
- The multi-lingual PM is fluent in three of the country’s main languages – Afaan Oromo, Amharic and Tigrinya – and speaks English
- He has launched an ambitious climate change project to plant four billion trees
The charismatic 43-year-old has also been hailed for his domestic agenda.
Within months of coming to power he oversaw the release of the country’s political prisoners, condemning their torture and also freeing jailed journalists.
He has also engaged with political opponents and invited exiles to return.
In a further progressive move, he appointed women to half of his cabinet.
But while his changes have been welcomed by the international community he has also faced criticism at home.
Accused of pandering to the West, his personality-driven leadership style has led to claims of narcissism.
Since 1901, 99 Nobel Peace Prizes have been handed out, to individuals and 24 organisations.
The honour brings with it a 9m Swedish kronor (£735,000) cash award, a gold medal and a diploma.
Unlike the other Nobel honours, which are received in Stockholm, the peace prize is awarded in the Norwegian capital, Oslo.
The ceremony will be held on 10 December, the anniversary of Alfred Nobel’s death in 1896.
The Swedish industrialist and inventor of dynamite left the bulk of his fortune to create the prizes.