Baraja will come in as a replacement for Gennaro Gattuso, who was sacked in late January following a poor run of form.
Valencia were 14th when Gattuso was sacked but have dropped into the relegation zone after a run of three straight defeats under regular caretaker boss Voro Gonzalez.
Baraja spent a decade as a player at Valencia in what was one of the most successful periods in the club's history.
The 47-year-old made 364 appearances for Los Che, winning two La Liga titles, a Copa del Rey, one UEFA Cup and one UEFA Super Cup.
Baraja, who won 43 caps for Spain, will be assisted by another former Valencia favourite Carlos Marchena.
A Valencia statement read: "'Pipo', one of the most decorated and illustrious players in the history of Valencia CF, knows the idiosyncrasies of the club and returns home to contribute with his professionalism and commitment as a coach after forging his legendary figure in the 2000s by helping to win two La Liga titles, a Uefa Cup, a European Super Cup and a Copa del Rey.
"In the coming days he will take charge of the team at the Ciutat Esportiva de Paterna and his coaching staff will include another Valencia CF legend, Carlos Marchena."
Baraja's first game in charge of Valencia will come against Getafe on Monday.
