Ms Palin, 44, was elected in 2006 as Alaska's first female governor. The mother of five built a reputation as a reformer in a state that recently has been hit with corruption scandals.
The surprise choice marks a huge political risk by John McCain, and a blatant bid to win over disgruntled Hillary Clinton supporters.
Ms Palin is also expected to appeal to the Republican's grassroots conservative base, as she is strongly pro-life and backs the gun lobby.
She is best known for aggressively pushing for drilling in the Arctic National Wildlife Refuge, a key part of the McCain energy policy.
However picking such a long-shot candidate could undermine Mr McCain's accusations that Barack Obama lacks the experience to be commander in chief.
'She will be his partner in reforming Washington,' a senior McCain official told reporters.
By announcing his pick today, John McCain is hoping to divert attention from the Democratic convention in Denver, which concluded last night with a speech by Barack Obama.
The Democratic candidate opened a broad assault on Mr McCain, accusing him of following the policies of unpopular President George W Bush.
Mr McCain is preparing to accept his party's nomination for president at the Republican convention in St Paul, Minnesota, next week.
'This is a bold choice of a strong conservative who is a reformer and will be greeted by the delegates in St Paul with enthusiasm,' said Republican strategist Scott Reed.
