The former Ireland coach, who has been in charge of the English Premier League club since 2006, apologised for their 5-1 defeat to the Midlands rivals on Sunday.
Wolves dismiss coach Mick McCarthy after home defeat to West Brom
The former Ireland coach's last match in charge of Wolves was Sunday's 5-1 home loss to West Bromwich Albion, their Midlands rivals, a result that plunged the team into the relegation zone with 13 matches remaining this season.
"The board took the difficult decision to terminate Mick's contract after a run of form which has seen Wolves pick up only 14 points from the last 22 league games," Wolves said in a statement.
McCarthy, who is the third manager to lose his job in the Premier League this season after Steve Bruce and Neil Warnock, joined Wolves in July 2006 when the team was in the second-tier League Championship and led it to promotion in 2009.
Wolves are 18th in the 20-team standings, two points above bottom team Wigan Athletic.
"The board would like to place on record their sincere thanks and appreciation to Mick McCarthy and he leaves with the very best wishes," Wolves said.
McCarthy, who was a tough-tackling defender as a player and is renowned for his bluntness and honesty as a manager, apologised on Sunday for the team's lacklustre display against West Brom at Molineux, which led to a small demonstration by fans after the game.
"The saddest part is that we capitulated, which I have never seen my team do - not really," McCarthy said. "That's not us.
"I have never apologised for a performance but would do for that as I know what it means to everybody."
Terry Connor, the Wolves assistant manager, will take charge of the first team while the club search for McCarthy's replacement.
Wolves only secured their Premier League status last season with a victory on the final weekend.