Having retired in 2006, Schumacher, who turns 41 on January 3, will reportedly be paid €7 million to be on the grid when the new season starts with the Bahrain Grand Prix on March 14.
"After a three-year break, I have all the energy again that I was lacking," Schumacher told a teleconference with reporters after signing the contract late Tuesday.
"We are talking about a three-year deal. It's not just a one-off thing. We are talking about continuation."
Schumacher had been due to make a remarkable return last season for Ferrari - for whom he acted as a consultant after retiring - as a replacement for the injured Felipe Massa but was unable to because of a neck injury.
But the German said Wednesday the pain was behind him.
"My neck is no longer a problem," Schumacher said. "Over the summer it was too soon after the accident. Now everything has healed."
The pilot will return to Formula One having won 91 of his 250 Grand Prix races and started in Pole Position 68 times.
His presence on the grid will electrify the hugely popular sport as he goes up against the likes of reigning champion Jenson Button, 2008 winner Lewis Hamilton and Ferrari-bound Fernando Alonso, all men much younger than he.
Said Hamilton: "It's great to have Michael back in Formula One. He is a legend, a really nice guy, and I am happy for him he has again got an opportunity to do the best job in the world - race in Formula One.
"I used to watch Michael race when I was in the junior categories, and I always hoped I would be in Formula One while he was still around. I'm now really looking forward to seeing him on the track and back at the top.
Schumacher will be linking up with Mercedes' team principal Ross Brawn, who was the brains behind all of his world titles.
The German won the first of his World Drivers' Championship titles at Benetton in 1994 and was successful with the Italian team again in the 1995 season.
In 1996, he transferred to Ferrari where he proved virtually unbeatable between 2000 and 2004, winning five further world titles. There will be huge interest in the impact Schumacher and Brawn will have now for Mercedes.
It will be 1239 days after Schumacher's last Formula One race in Sao Paulo at the Brazilian Grand Prix in October 2006 and he joins Mercedes in an all-German racing team after compatriot Nico Rosberg, 24, signed up last month.
Brawn said that Schumacher's record spoke for itself.
"With the completion of our driver line-up, I believe we now have the most exciting partnership in Formula One with Michael and Nico, who provide the perfect mix of talent, experience, speed and youth." he added.
Schumacher's signature is a major coup for Mercedes, who raced under the Brawn GP banner last season, and a blow to his former stable.
Ferrari president Luca di Montezemolo admitted last week he is distraught at the prospect of losing Schumacher to a rival team.
Di Montezemolo started working with Schumacher in 1996, when the German joined the Italian constructor from Benetton.
It was the Italian who first suggested to Schumacher he stand in for the injured Massa after the Brazilian's horrific crash at the Hungarian Grand Prix in July.
"It was me that rekindled his desire to race after Massa was injured in Hungary," the Ferrari chief had said.
Di Montezemolo admits he would have liked to see Schumacher back in a Ferrari but with Massa and Alonso already on their books for next season he simply could not offer the German a drive.
It remains to be seen how the German can cope with the inevitable march of Father Time, but his famous dedication to fitness and healthy living means that at 41 he has lost little of his punch.
Former world champion Niki Lauda for one believes that he could deliver.
"He can win again," said the Austrian, who himself twice made comebacks to win the world title. "He has more potential that all his younger rivals."