The experienced manager has been in charge of the national team since 2010 and guided them into the final of Euro 2012 two years ago.
It had been suggested that Prandelli would seek pastures new after this summer's World Cup, but he will now remain in charge until at least the end of Euro 2016.
"At this moment I feel a great satisfaction," Prandelli told ANSA.
"I'm proud of the fact that the Italian football association has proposed a two-year renewal to me, regardless of the outcome of the World Cup.
"For this reason I have given my full availability."
Prandelli has previously managed the likes of Parma, Roma and Fiorentina.