The 28-year-old playmaker recently said he was committed to staying with Wolfsburg until his contract with the Bundesliga club ran out in the summer, but he was unable to turn down the chance to go back to Madrid.
He said on clubatleticodemadrid.com: "I feel very excited. I'm returning to team where I felt fantastically well. I'm only thinking about getting to work to help the team continue winning."
Wolfsburg director of sport Klaus Allofs admitted they would like to have kept hold of Diego.
He said: "Diego came to us with the request to be able to move to Atletico. We ultimately agreed to it, even if we would have liked to have carried on working with Diego at least until the summer.
"His immediate transfer is regrettable because Diego has always been highly-professional, but hopefully it only means a short-term drop in quality for our team.
"We still have a good enough squad to be able to carry on following our objectives and we wish Diego much joy and success with Atletico."
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