The 22-year-old established his place in Sam Allardyce's squad last season and has been rewarded with a deal that ties him to the Lancashire side until the summer of 2015.
Olsson, who made his international debut last month, is the second young player Rovers have signed on a five-year contract this summer after promising teenage defender Phil Jones also committed himself to the club.
Olsson, who signed from Swedish club Hogaborgs in 2006, was originally played as a left-back but blossomed last season after also being utilised as a winger.
He scored Rovers 'Goal of the Season' in their Carling Cup semi-final defeat to Aston Villa while he was twice on target for Sweden on his debut against Bosnia and Herzegovina.
"Signing a new contract is easy for me after the enjoyment of last season," he told the club's official website www.rovers.co.uk.
"I gained a lot of confidence, through both the management and my team-mates, and I thought I improved game by game.
"I got my chance and I felt I took it and it doesn't matter to me whether I am seen as a left winger or left back, as long as I am playing and contributing then I am happy.
"But I must say that I have enjoyed the forward role and the chance to get among the goals.
"I have relaxed more and I am already looking forward to next season for I feel I can get better."
Manager Sam Allardyce added: "Martin was outstanding for us last season, a young player who came in and made a magnificent contribution.
"He has really started to understand the game and now knows how best to use his talents to the team's advantage.
"I am absolutely delighted that another of our young starlets has pledged his long-term future to Rovers - that can only be good news, very good news indeed."