Dolberg, who joined Nice from Ajax this summer, saw the item stolen from the team’s dressing room on September 16 and he reported the case to police, who launched an investigation.
Diaby admitted stealing the watch, which reportedly cost £62,000, and apologised to his teammates before reimbursing Dolberg.
“OGC Nice and Lamine Diaby Fadiga parted ways on Tuesday,” Nice said in a statement.
“Following the theft of Kasper Dolberg’s watch from the professional first team’s changing room, and the subsequent admission of the player, the club decided to cancel its contract with the 18-year-old forward with immediate effect.
“Above and beyond all sporting and financial consideration, Nice cannot and will not accept such behaviour that betrays the confidence that unites all the club’s employees and all the members of the Rouge et Noir [Red and Black] family.”
Diaby joined Nice as a 13-year-old before breaking into the first team last season when he made six Ligue 1 appearances.
The 18-year-old is yet to feature in the league this season.
Diaby is of Guinean descent but has represented France at youth level.
French Ligue 2 side Paris FC are reportedly ready to swoop for Diaby after his disengagement with Nice was confirmed.
Nice, who are managed by former Arsenal captain Patrick Vieira, are sixth in Ligue 1 with 12 points from their first eight games.
