Lyon have the option to extend the contract by another year if they are impressed.
Grosso comes in as a replacement for Laurent Blanc, who was sacked on Monday after a disastrous start to the season.
Lyon are bottom of the French Ligue 1 table after picking only one point from their opening four games.
Grosso is returning to a club he represented for two years during his playing days, winning one league title in the process.
The 45-year-old, who struck the decisive penalty kick when Italy beat France to win the 2006 FIFA World Cup, will start work on Monday after watching Lyon from the stands against Le Havre on Sunday.
An official club statement read: "Olympique Lyonnais is delighted to announce the appointment of Fabio Grosso as the head coach of the professional team, effective from Monday, September 18.
"The former Italian international defender, World Cup champion in 2006, has committed to the club until June 30, 2024, with the option to extend his contract for an additional season."
Grosso's last managerial role was at Frosinone in Serie B but left after guiding them into the Serie A at the end of the 2022/2023 season.
