The former Yorkshire batsman – brother of Preston North End football manager Simon – takes charge of a side that finished second-bottom of the inaugural Super League, losing four of their five games.
The 45-year-old replaces Rich Pyrah, who is to work more closely with new Yorkshire first-team coach Andrew Gale.
Grayson’s contract runs until the end of 2019 and follows an eight-year spell as Essex coach.
“I am delighted to be joining as head coach,” said Grayson, who will continue to coach Durham MCCU alongside his new role.
“The opportunity to work with an elite female team is really exciting for me and a role which gives me a fantastic opportunity to use my first-class coaching experience.
“I am looking forward to meeting up with players and the Diamonds support staff very soon and preparing for Super League competition.”
Jane Hildreth, Yorkshire Diamonds’ general manager, commented: “I am thrilled that we have been able to recruit Paul as head coach.
“Paul has a wealth of experience in the game, having had a successful coaching career with Essex County Cricket Club and Durham University MCCU.
“Paul will take the Yorkshire Diamonds forward and build a team who will be challenging for the title in 2017.
“We are all excited to be working with Paul and look forward to welcoming him back to Headingley.”
Grayson played 52 first-class matches for Yorkshire between 1990 and 1995, scoring 1,958 runs at 27.97.
The Diamonds will begin their Super League programme against Lancashire Thunder at Headingley on Friday, August 11.
Yorkshire pace bowler Matthew Fisher missed yesterday’s third Under-19s one-day international betweeen England and India in Mumbai with a pulled groin.
Fisher, the Under-19s captain, took four wickets in each of the first two matches.
In his absence, England lost by seven wickets to fall 2-1 behind in the five-game series.