The award was announced by Peter Englund, Permanent Secretary of the Swedish Academy, who said that the French writer was being recognised for "the art of memory" in capturing the lives of ordinary people under the World War II occupation, from 1940 to 1944.
Modiano, is a French historical novelist whose work is largely inspired by Paris under the Nazis.
On Thursday Modiano described his win as "a bit unreal" and dedicated it to his Swedish grandson.
Speaking hours after the prize was announced, the publicity-shy 69-year-old writer told reporters in Paris: "It seems a bit unreal to me," adding that it was as if it was happening to someone else.
"He evoked the most ungraspable human destinies and uncovered life under of the occupation," Englund said.
"This is someone who has written many books that echo off each other… that are about memory, identity and aspiration," said Englund.
(He might not be well known outside France but news of Modiano's win dominated French news sites on Thursday)
"Patrick Modiano is a well-known name in France, but not anywhere else. He writes children's books, movie scripts but mainly novels. His themes are memory, identity and time.
Modiano will take home 8.0 million Swedish kronor – just over $1,113,000.
A collection of the work of French Nobel Laureate Patrick Modiano. pic.twitter.com/6SrRL7B7Rd
— Oliver Gee (@TheUppsalaKoala) October 9, 2014
Modiano has been writing since the 1960s and will turn 70 next year, but has had very little of his work published in English.
That may all change after Thursday's announcement of course.
He was born in a west Paris suburb two months after the second world war ended in Europe in July 1945.
The Nazi occupation of France has provided the material for a large part of Modiano's literary production.
Modiano, described by one critic as "1 metre 90 of shyness and candor," is one of France's most celebrated writers, and a winner of the country's top award the Goncourt.
The 69-year-old has described the occupation of France as "the soil I grew up in".
— Michael Balter (@mbalter) October 9, 2014
Apart from a long series of books, in the early 1970s, Modiano co-wrote the screenplay for Lacombe Lucien, a movie directed by Louis Malle focusing on French collaboration with the Nazis.
In a 2012 interview with Le Figaro newspaper Modiano compared writing to driving in fog: "You don't know where you're going, you just know you have to go on."
He will be presented with his award at a formal ceremony in Stockholm on December 10, the anniversary of prize founder Alfred Nobel's death in 1896.
A total of 210 people were nominated for the award in 2014, with other names touted for the prize including US singer-songwriter Bob Dylan, Syrian poet Adonis, Canadian poet and novelist Margaret Atwood, British novelist and essay writer Salman Rushdie and Austrian novelist Peter Handke.
Last year the prize was picked up by Canadian short story writer Alice Munro.