Davies began his second spell in charge of Forest in February, spearheading a playoff charge which came up just short on the final day of the campaign.
Forest have continued that fine form in the Championship this season, winning four of their first five home games to sit fourth in the table.
The Scot has added two years to his deal with the Reds, prompting Forest chairman Fawaz Al Hasawi to share his delight at securing Davies's services on a long-term basis.
Al Hasawi told the club's official website: "This is a fantastic day for Nottingham Forest.
"Billy and I have the same long-term vision for the club and I am absolutely delighted that he has agreed to sign an extension to his contract.
"I look forward with great excitement to working alongside him for many years to come as we aim to bring success back to this magnificent club."
Forest's continue their Championship campaign tomorrow afternoon against newly-promoted Bournemouth.