Former Portsmouth, Blackpool and Blackburn manager Appleton, 40, joined the U's in the summer of 2014.
He has guided them to the Johnstone's Paint Trophy final at Wembley and into contention for automatic promotion to League One this season.
"It was an easy decision to sign," Appleton said. "All I've ever wanted is to help take the club forward."
Confirmation of a new deal ends four months of discussions between Appleton and the club.
"I'm pleased to get everything sorted and be able to focus solely on the remaining five games of the season, starting against Luton on Saturday," he added.
Oxford are currently second in League Two, four points above the play-off places.
Chairman Darryl Eales said the deal will allow the club to continue "building for the long-term future".
He continued: "I'm delighted Michael has agreed to be part of what we are trying to build here.
"He is very honest, very hard-working and has the greatest respect of everyone not just at the club but also within football."
Michael Appleton has agreed a new rolling contract as head coach of League Two club Oxford United.