Although no financial details of the transfer were released, media reports suggested Watford paid 2.3 million pounds ($2.89 million) to lure Zarate back to England.
"The Hornets are delighted to announce the permanent signing of Argentine forward Mauro Zarate," a club statement said.
The 29-year-old joins his fourth top-flight club in England, having already played for West Ham United, Queens Park Rangers and Birmingham City.
Manager Walter Mazzarri will hope Zarate adds some much-needed firepower to his side, whose joint top scorers, midfielder Etienne Capoue and striker Troy Deeney, have just five league goals each this campaign.
Zarate is Watford's second signing this month, following the arrival of midfielder Tom Cleverley on loan from Everton.
Watford, who are 14th in the league, travel to face Millwall in the FA Cup on Sunday before a trip to take on second-placed Arsenal two days later.
(Reporting by Shravanth Vijayakumar in Bengaluru; Editing by Ken Ferris/Mark Heinrich)
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