Mohammadi's award comes after a wave of protests swept Iran after the death in custody a year ago of a young Iranian Kurd, Mahsa Amini, arrested for violating Iran's strict dress rules for women.
A journalist and activist, Mohammadi has spent much of the past two decades in and out of jail for her campaign against the mandatory hijab for women and the death penalty.
Speaking to AFP, the head of the Norwegian Nobel Committee urged Iran to release Mohammadi, a call immediately echoed by the United Nations.
"I appeal to Iran: Do something dignified and release the Nobel laureate Narges Mohammadi," chairwoman the committee Berit Reiss-Andersen said.
FILE - A dove of peace flies from the window of the Nobel Peace Center in connection with the announcement of the 2023 Nobel Peace Prize winner in Oslo, Norway, October 6, 2023.
The recent protests in Iran "accelerated the process of realising democracy, freedom and equality in Iran," a process that is now "irreversible," Mohammadi told AFP last month in a letter written from her prison cell.
She and three other women held with her at Tehran's Evin prison burned their hijabs to mark the anniversary of Amini's death on September 16.
Reiss-Andersen began this year's highly-anticipated announcement with the words "Zan, Zendegi, Azadi," Farsi for "Woman, Life, Freedom," the name of last year's uprising.
- Crackdown -
Mohammadi, whose name had been mentioned in the run-up to the announcement as a possible winner, was honoured "for her fight against the oppression of women in Iran and her fight to promote human rights and freedom for all," Reiss-Andersen said.
"Her brave struggle has come with tremendous personal costs. Altogether, the regime has arrested her 13 times, convicted her five times, and sentenced her to a total of 31 years in prison and 154 lashes," she added.
FILE - Prominent Iranian human rights activist Narges Mohammadi is seen in a meeting on women's rights in Tehran, Iran, on July 3, 2008.
Iran is ranked 143rd out of 146 countries on the World Economic Forum's gender equality ranking.
Authorities cracked down harshly on last year's uprising.
A total of 551 protesters, including 68 children and 49 women, were killed by security forces, according to Iran Human Rights, and thousands of others were arrested.
The movement has since continued under other forms.
In what would have been unthinkable a year ago, women now go out in public without the headscarf, in particular in Tehran and other big cities, despite the risks.
Wearing the hijab is one of the pillars of the Islamic republic.
Authorities have stepped up controls, using surveillance cameras among other things, and have arrested actresses who post pictures of themselves on social media without the hijab.
In September, Iran's conservative-dominated parliament announced heavier penalities for women who refuse to wear it.
- 'No prospect of freedom' -
Calling Mohammadi the "undisputed leader" of the uprising, Reiss-Andersen said "this year's Peace Prize also recognises the hundreds of thousands of people who in the preceding year have demonstrated against the theocratic regimes policies of discrimination and oppression targeting women."
Offenders will face heavy prison sentences if the "Hijab and Chastity" bill is approved by Iran's Guardian Council.
Incarcerated this time since November 2021, Mohammadi has not seen her children, who live in France with her husband, for eight years.
FILE - Iranians protest a 22-year-old woman Mahsa Amini's death after she was detained by the morality police, in Tehran, Sept. 20, 2022, in this photo taken by an individual not employed by the Associated Press and obtained by the AP outside Iran.
Considered a "prisoner of conscience" by Amnesty International, she told AFP in her letter that she had "almost no prospect of freedom."
She is the second Iranian to win the Nobel Peace Prize, which comes on the 20th anniversary of the award to Iranian human rights lawyer Shirin Ebadi, who was honoured "for her efforts for democracy and human rights," especially those of women and children.
In 2003, Ebadi defied conservative Iranians by refusing to wear the hijab when she received her prize in Oslo.
This year's prize also symbolically coincides with the 75th anniversary of the UN Universal Declaration of Human Rights.
If she remains behind bars, Mohammadi will not be able to make the trip to Oslo to receive her award, consisting of a diploma, a gold medal and $1 million, at the annual prize ceremony on December 10.
The Peace Prize has on several occasions honoured jailed activists, including last year when it went to Ales Bialiatski of Belarus, whose prize was accepted by his wife, and Chinese dissident Liu Xiaobo in 2010, whose chair remained empty.