The 21-year-old has become a regular fixture for Wolves since making his debut against Blackburn Rovers last month.
Speaking about his new contract, the midfielder has revealed that he is delighted to be continuing his career with the recently-relegated club.
"Obviously, us getting relegated has been a bitter disappointment but I think that we can bounce back and I would like to play my part in that objective," he told the club's official website.
"This new contract really is the icing on the cake for me. It's secured my future at my club Wolves, the club I want to play for. It really is a dream come true."
Davis has made six appearances for Wolves this season.