The 48-year-old took charge of the Bantams following Stuart McCall’s sacking in February on a short-term deal until the end of the season.
He had hoped to inspire a turnaround in form at Valley Parade following the six game losing run that brought an end to McCall’s reign.
However, Grayson’s 14 games in charge yielded just three wins and Bradford finished 11th in League One.
With the play-offs out of reach, talks began between Grayson and the club’s owners over the future. All manner of topics were discussed, from the size of next season’s playing budget to the need to improve the infrastructure surrounding the first team.
City had hoped Grayson would stay but he has chosen to leave, meaning the search for a new manager is under way.
Glynn Snodin, Grayson’s long-time assistant, has also left Valley Parade.
“After conversations with the owners I have decided to turn down the option to extend my contract,” said Grayson. “This was an extremely difficult decision as I have enjoyed my time at Valley Parade.
“I would like to thank everyone at Bradford City, from the owners to the supporters, who have turned out in their numbers both home and away since I have been manager of their club.
“I wish the club all the best for the future.”