Abed Hakim Assi, born in 1998, is believed to have stabbed to death Itamar Ben Gal, 29, near the settlement of Ariel on February 5 before going into hiding in the northern West Bank.
Israel's Shin Bet domestic security agency announced the overnight arrest in a statement.
Palestinians who were with Assi during his arrest were also taken for questioning, the statement said.
Ben Gal, of the Har Bracha settlement, was seen in a video waiting for a bus while a man Israei authorities identified as Assi crosses the road and stabs him in the chest.
Assi's mother is an Arab Israeli and his father a Palestinian from the West Bank, the Shin Bet said.
According to media reports, he was living in Tel Aviv prior to the attack and had a background of drug abuse and social problems.
The arrest comes on the heels of a car ramming attack by a Palestinian near Jenin in the northern West Bank on Friday that killed two Israeli soldiers and wounded two others, according to the army.
Tensions were high after Palestinian Islamist movement Hamas called for a day of rage on Friday to commemorate 100 days since US President Donald Trump's controversial recognition of Jerusalem as Israel's capital.
Palestinians also see the city as their capital and Trump's recognition broke with decades of US policy that Jerusalem's status would be negotiated between the parties.
At least 31 Palestinians and four Israelis have been killed since Trump's announcement, which set off major protests.
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