The former Spurs midfielder has been in caretaker charge at White Hart Lance since Andre Villas-Boas' tenure came to an end following a 5-0 home defeat to Liverpool earlier this month.
Sherwood has overseen a League Cup loss to West Ham and Sunday's 3-2 victory away to Southampton in the Premier League.
"We were extremely reluctant to make a change mid-season, but felt we had to do so in the club's best interests," Levy said in a statement on the club's official website.
"We have a great squad and we owe them a head coach who will bring out the best in them and allow them to flourish and enjoy a strong, exciting finish to the season.
"We are in the fortunate position of having within our club a talented coach in Tim Sherwood.
"We believe Tim has both the knowledge and the drive to take the squad forward."
Sherwood's first-team coaching staff also includes Chris Ramsey, Les Ferdinand and Steffen Freund.
