"He has worked consistently for a democratisation of Chinese society, while condemning any form of violence as a political method," the Stockholm-based Olof Palme Memorial Fund said in a statement.
"Through his research and dialogue-oriented debate articles, Xu Youyu has made a great contribution to the peaceful and democratic development in China."
Born in 1947, Xu is a philosophy professor at the Chinese Academy of Social Science and was one of the most prominent signatories of the 2008 Charter 08 manifesto that urged a series of reforms in China.
He was detained in May this year in a crackdown on dissent ahead of the 25th anniversary of the Tiananmen Square massacre.
The Olof Palme Prize is an annual prize worth $75,000 granted by the Swedish labour movement. It commemorates the memory of the Social Democratic prime minister, an outspoken international human rights advocate, who was assassinated in the Swedish capital in 1986.
Since 1987 the award has been awarded to human rights defenders around the world including Burma'a Aung San Suu Kyi and former UN Secretary General Kofi Annan.