 Nalbandian came back from a bad start to win in style |
Federer took the first set with ease, but Nalbandian broke in the second game of the second set and went on to level.
And defending champion Federer made further errors in the third set.
"I'm extremely contented to beat the world number one. Roger and I have a long history and I think that influenced the match," said Nalbandian.
Speaking about the opening set, Nalbandian said: "It was an extremely hard set. But I tightened the teeth and I began to play more strongly. 
"Things came out fine, Today I played incredible."
The unseeded Argentine also beat world numbers two and three Rafael Nadal and Novak Djokovic on his way to the final.
It was Federer's first loss on indoor hard courts since the Argentine rallied to beat him at the Masters Cup in Shanghai nearly two years ago.
Nalbandian has slipped to 25th in the rankings this season, but after his shaky start in the opening set he became the first player to crack the Federer serve during the tournament.
It was Federer's first defeat since he lost to Djokovic in the final of the Montreal Masters in August and only his seventh loss of the year.
Federer had beaten Nalbandian in eight of their last nine meetings including a 6-4 6-0 win in the semi-final in Madrid last year.
"He served well, I was quite surprised with how well he served," said Federer.
"He came back strong and played well in the end.
"He was a better player all in all. I was struggling after the first set to play aggressive for some reason. He played tough and didn't miss any more.
"I couldn't play way I wanted to. It was a pity, he played a great tournament."
