The 32-year-old centre-half has signed a two-year contract at The Hawthorns after struggling to make an impact during two seasons with PSG.
Lugano struggled with injury and poor form following his 2011 arrival from Fenerbahce and was overlooked by former coach Carlo Ancelotti last season.
The Uruguay international spent the second half of last term on loan at Malaga and has now secured a permanent exit away from the French champions.
"I am very pleased to join West Bromwich Albion for the next two years," Lugano wrote on his Twitter account.
Lugano was in attendance for West Brom's 1-0 defeat by Genoa in a pre-season friendly at Telford's ground on Thursday night.
He also follows another former PSG and Fenerbahce player to West Brom after Nicolas Anelka signed on a free transfer earlier in the summer.
And he added: "I'm doing something that has been missing in my career, playing in the Premier League, without doubt the most beautiful and competitive league in the world.
"The challenge is to match what West Bromwich achieved last season and trying to go a step further to reach European competitions."
West Brom head coach Steve Clarke told the club's official website: "I'm delighted to welcome Diego to the club.
"He's an experienced centre-half who will increase competition in that area of the team.
"This is a tough league. You need as many good players in your squad as you can get - and Diego is undoubtedly one of those.
"Like some of the others we have here, Diego is another player who captains his country and is a leader.
"He has a real hunger and ambition to play and succeed in the Barclays Premier League and he will hopefully get a platform here to show everyone what he can do.
"However, Diego knows he's got a fight on his hands to get into the team.
"Over the past couple of seasons, Gareth McAuley and Jonas Olsson have been an established Premier League pairing with stiff competition from Gabriel Tamas and young Craig Dawson, who we believe will be a good centre-half for this club in years to come."
Lugano, who began his career with Nacional in his homeland before moving to Sao Paulo in Brazil, has played in Europe since joining Fenerbahce in 2006.
After making 12 league appearances in his first season at PSG, he was pushed further down the pecking order by the arrival of the likes of Thiago Silva.
PSG have further added to their defensive ranks this summer with the 32million euro (£27.8million) signing of 19-year-old Brazilian Marquinhos from Roma, making Lugano expendable.
A PSG statement read: "Paris Saint-Germain thanks Lugano for the professionalism he has shown throughout his contract and wishes him well in the English league."