The Argentina international moved to the Etihad Stadium on a two-year contract in September 2013 and was a key member of the side that clinched a double of the Premier League and League Cup last season.
Demichelis has gone on to make 30 appearances across all competitions this term and expressed his delight at extending his stay in Manchester.
"I want to say that I am really proud and happy to have extended my contract for another year," he told the club's official website.
"Manchester City is a club with a lot of ambition. We want to grow every year.
"When you get to hold a trophy, it's the best feeling for any player.
"I want to say that I will fight for this club and for my team-mates until the end of my contract. I will fight to try and win titles."
Demichelis endured a challenging start to life in England, but soon established himself alongside captain Vincent Kompany at the heart of City's defence last term.
The signing of Eliaquim Mangala from Porto last August added competition for places in defence.
However, the experienced centre-back has still made 22 Premier League appearances this term and the former Bayern Munich man has not ruled out extending his stay beyond 2016.
"We are happy here - my wife and son are happy here. We are trying to improve our English and I think that's a good thing for our future," he added.
"At this stage I am enjoying playing week to week - you can never say what can happen in the future."
Demichelis started his career at River Plate in his homeland where he played under City boss Pellegrini.
A fruitful seven-year spell at German giants Bayern Munich followed where he won the Bundesliga title on four occasions.
Pellegrini then swooped to sign Demichelis a second time when he took to La Liga side Malaga during the 2010-11 season.
Get the best features, fun and footballing frolics straight to your inbox every week.
Thank you for signing up to Four Four Two. You will receive a verification email shortly.
There was a problem. Please refresh the page and try again.