The president says he accepts the prize as a "call to action" to work with other countries to solve the world's most urgent problems. He says he's surprised and humbled by the honor.
It comes just 9 months into his presidency.
"I do not view it as recognition of my own accomplishments, but rather as an affirmation of American leadership on behalf of aspirations held by people in all nations," Obama said.
The award also came as a surprise to people who worked with the president at the University Of Chicago and people who live in his South Side neighborhood.
He found out early this morning that he'd won. He says he didn't even know he was nominated.
Critics and the president himself question whether he deserves the award.
Few phone calls reach the White House situation room at 6 a.m. bearing good news, but a call Friday morning informed the president he had just won one of the world's most prestigious awards.
"This is not how I expected to wake up this morning," Obama said.
Just nine months into office, President Obama concedes the Peace Prize is as much about promise as it is actual achievement.
"To be honest, I do not feel that I deserve to be in the company of so many of the transformative figures who've been honored by this prize," he said.
The Nobel committee cited several speeches the President gave at home and abroad promoting ideals such as nuclear disarmament and a new era of understanding with the Muslim world.
"We felt that Obama has already achieved a very significant change in the international climate," said Ger Lundestad, Norwegian Nobel Institute.
The award strikes many as puzzling, especially in places such as Afghanistan and the Middle East, where the president's policies have yet to bare fruit.
"Since Obama has taken over we have seen no improvements here, things have only gotten worse," a man in Afghansitan said.
"He's trying to bring peace to the world but he doesn't know how to do it," a man in Israel said.
The head of the Republican National Committee sent a statement instead of flowers.
"One thing is certain - President Obama won't be receiving any awards...for job creation, fiscal responsibility or backing up rhetoric with concrete action," Michael Steele said.
"It's as though they're giving it to him on speculation. They're saying, 'Here's the prize now go out and earn it,'" said Associate Professor Scott Paeth, DePaul University.
Deserving or not, President Obama becomes only the third Chicagoan to win the Nobel Peace Prize.
In 1925, Charles Dawes received the award for his plan to solve Germany's post-war financial problems.
Six years later Jane Adams was honored for her humanitarian work.
In the President's Hyde Park neighborhood, a local restaurant owner put the "Obama Special" back on the menu today.
"I think the attitude of the world will change. We'll be more diplomatic rather than pushing people around," said Hyde Park resident David Ray
The Nobel Peace Prize comes with a $1.4 million cash award. The president says he'll donate the entire amount to charity.
He may not feel he's worthy, but Obama says he will travel to Norway in December to receive the award.