Clement was sacked as Swansea City head coach in December, but the 46-year-old has been given the responsibility of trying to keep Reading at the second tier.
Chief executive Ron Gourlay told the club's official website: "I am delighted to have secured the services of a hugely experienced forward-thinking manager like Paul, who I have personally worked alongside during our time spent at Chelsea.
"Not only has he coached at some of the greatest clubs in Europe, winning trophies, league titles and European honours and working with some of the greatest players in the world, fundamentally he also has a rich understanding of English football having managed in both the Championship and the Premier League in recent years.
"Now, everyone at Reading football club is fully behind Paul and his squad of players as, together, we initially set our sights on an eight-game battle and continue to strive to the take this club forward."
Reading - who currently sit three points above the relegation zone - are next in action when they host Queens Park Rangers on March 30.