He will succeed U K Sinha, whose extended tenure ends on March 1.
Tyagi, a 1984 batch IAS officer of Himachal Pradesh cadre, is at present Additional Secretary (Investment) in the Department of Economic Affairs and handles capital market, among others.
Tyagi has been appointed as chairman of the markets regulator, an official order said.
The Appointments Committee of the Cabinet-headed by Prime Minister Narendra Modi has approved Tyagi's appointment for a period not exceeding five years or till the age of 65 years, it said.
58-year-old Tyagi hails from Uttar Pradesh.
As per the eligibility criteria, a person can hold the position of Sebi chairman till the age of 65 years or for a term decided by the government.
Sinha, a 1976 batch IAS officer of Bihar cadre, had assumed office as the Sebi chairman on February 18, 2011, when the previous UPA government was in power.
He was later given a two-year extension. Days before the end of his tenure in February last year, he was given another extension till March 1, 2017.
Many senior bureaucrats, including some Secretary-level officers, were in contention for the top post of capital market regulator.
Tyagi for a short while was also on the board of Reserve Bank of India (RBI).
The process for selecting the next chief of the Sebi started in September 2015, pursuant to which several applications were received for the position.
"Keeping in view the role and importance of Sebi as a regulator, it is desirable that persons with high integrity, eminence and reputation preferably with more than 25 years of professional experience and in the age group of 50-60 years may apply," the Finance Ministry had said while inviting applications for the post.
However, the government had in February last decided to give a one-year extension to Sinha to ensure stability due to volatile market conditions.
Sebi chairman receives consolidated pay package of Rs 4.5 lakh per month.
Besides chairman and whole-time members, the Sebi board includes independent members and nominees of Finance Ministry, Corporate Affairs Ministry and the RBI.