The award is considered the top prize in the field. It is sometimes called the Little Nobel Prize for Literature.
The jury said Cao was a unanimous choice for the writing prize, because he "writes beautifully about the complex lives of children facing great challenges".
The Peking University professor of Chinese and children's literature is well known in literary circles in China, and has won several prizes at home.
He is known particularly for his books set in 1950s and 1960s rural China, drawing from his childhood experiences.
Cao, 62, grew up in backbreaking poverty in Jiangsu province, the son of a principal for rural primary schools.
In one of his books recounting his childhood, he recalled he often had nothing much to eat and would look forward to having a meal of rice gruel once every 15 days.
"My home village was well known for its poverty. Day in and day out, my family lived with deprivation," he wrote.
"I would gather grass from the riverbanks. Mother would diligently stir fry it in a oil-less steel wok, saying she was making me a dish of stir-fried leeks to eat."
The International Board on Books for Young People (IBBY), which gives out the Hans Christian Andersen Award, noted that "his childhood, though materially poor, was emotionally and aesthetically rich", attributes it said were evident in his writing.
One of Cao's best-known children's books outside China is his 2005 work Bronze and Sunflower, set during the Cultural Revolution.
It tells the tale of a young city girl, Sunflower, who accompanies her artist father when he is forcibly sent to the countryside to labour among peasants, as millions of Chinese were in the 1960s and 70s.
She befriends a peasant boy, Bronze, who persuades his family to take Sunflower in after her father dies and looks out for her, while she teaches him to read and write.
Critics praised it for its meaningful story and Cao's lyrical prose.
"Bronze was hungry to learn and gobbled up every character Sunflower knew, writing them out on the ground and in his notebook. The two of them never stopped. Wherever they went, whatever they saw, Bronze wanted to know what the characters were...
Bronze saw the beautiful world around him transform into the magical world of characters. The sun became more gorgeous, more vivid, more enticing than ever. Likewise, the moon, the sky, the earth, the wind, the rain... everything took on a new life.
And Bronze, who was used to careering around the fields whatever the weather, was changing too. He was calmer than he used to be."
Translated from original Chinese text by Helen Wang
Another book published in 1997, Straw House, traces the coming of age story of a young village boy, Sang Sang, throughout his six years in primary school.
Cao told China's Xinhua news agency in 2007 that the book was based on his experiences as his family followed his father, who was often transferred from school to school across the province.
It won several prizes in China including the country's top National Children's Literature Award. "His fluid, poetic prose depicts honest, sometimes raw and often melancholy moments of life," said IBBY.
Chinese netizens welcomed the news of his win, with many agreeing it was well deserved.
Several said on microblogging network Sina Weibo that they had fond memories reading his books in school.
"The simple memories of childhood," commented one Weibo user, while another said: "His works were what our generation grew up reading, they were the books that accompanied us as we grew up."
Beijing-based author Cao Wenxuan has become the first Chinese author to win the Hans Christian Andersen award for children's literature.