Wolves paid 5 million euros ($5.4 million), according to media reports, for the player who featured at last year's World Cup and had a contract until 2024 with PSG.
Sarabia scored 22 goals in 98 appearances for PSG since joining the Ligue 1 side in 2019. He also had a brief loan spell with Sporting in Portugal in the 2021-22 season.
"A product of the world-renowned Real Madrid academy, (Julen) Lopetegui first spotted the midfielder while leading Spain’s under-19s group back in 2011, when he named Sarabia as his captain for Spain’s winning Under-19 European Championship campaign," Wolves said in a statement.
Lopetegui's team have also added Brazilian forward Matheus Cunha and Gabon midfielder Mario Lemina to their squad during the January transfer window.
Wolves are 16th in the Premier League standings and face Manchester City on Sunday.
