Estelle Merle O'Brien Thompson was born in Bombay (now Mumbai), India. Her mother, Charlotte, was an Anglo-Sinhalese nurse; her father, Arthur, was a British railway engineer. Merle was her mother's second child. Charlotte had abandoned her first daughter, Constance, and refused to take care of another child born out of wedlock. She insisted that Arthur marry her, although it is not clear if he actually did.

In 1914 when she was 3, Merle's father died of pneumonia on the Western Front in the early months of World War I. Mother and daughter led an impoverished existence in shabby Bombay apartments for a few years. Then, in 1917, they moved to better circumstances in Calcutta (now Kolkata). Merle received a foundation scholarship to attend La Martiniere College for Girls, a well known Calcutta private school. There, she was constantly taunted for her unconventional parentage and eventually quit school and had her lessons at home.

Merle first performed with the Calcutta Amateur Dramatic Society. She was also completely enamored by the movies and enjoyed going out to nightclubs. As she entered her teen years, she dated increasingly older, urbane men. In 1929, she met a former actor who claimed he could introduce her to Rex Ingram of Victorine Studios. Merle jumped at the offer and decided to follow the man to the studios in France. However, when he saw Merle's dark mother one night at her apartment and realized Merle was mixed-race, he secretly decided to end the relationship.

After packing all their belongings and moving to France, Merle and her mother found that their supposed benefactor had dodged them. However, he had left a good word for Merle with Rex Ingram at the studios in Nice. Ingram liked Merle's exotic appearance. She was quickly hired to be an extra in a party scene.

Merle arrived in England for the first time in 1928. Initially she worked as a club hostess under the name Queenie O'Brien and played in minor and unbilled roles in various films. Her first major film role was as Anne Boleyn in The Private Life of Henry VIII (1933) opposite Charles Laughton. In 1934, she played the female lead in The Scarlet Pimpernel, opposite Leslie Howard.

Oberon's career went on to greater heights partly as a result of her relationship with and later marriage to director Alexander Korda, who had persuaded her to take the name under which she became famous. She received her only Academy Award for Best Actress nomination for The Dark Angel (1935). She was to star in Korda's film of I, Claudius (1937) as Messalina, but a serious car accident resulted in filming being abandoned. Merle Oberon was scarred for life, but skilled lighting technicians prevented her injuries being spotted by cinema audiences. According to Princess Merle, the biography written by Charles Higham, Merle suffered even further damage to her complexion as a result of cosmetic poisoning and an allergic reaction to sulfa drugs.

She went on to appear as Cathy in Wuthering Heights (1939), as George Sand in A Song to Remember (1945), and as Empress Josephine in Désirée (1954). During her time as a film star, Oberon went to great lengths to disguise her mixed-race background and when her dark-skinned mother moved in with her in Hollywood, she masqueraded as Oberon's maid. Also, Oberon supposedly had a minor obsession with facial injuries after her own accident, and had an affair with Richard Hillary who had been burned after his Supermarine Spitfire was shot down in 1940.

Merle Oberon divorced Sir Alexander Korda in 1945, to marry cinematographer Lucien Ballard. She married twice more, to Italian-born industrialist, Bruno Pagliai (with whom she adopted 2 children) and Dutch actor Robert Wolders (who would later become Audrey Hepburn's companion), before her retirement in Malibu, California, where she died after suffering a stroke at the age of 68.

She was interred in the Forest Lawn Memorial Park Cemetery in Glendale, California.

She has a star on the Hollywood Walk of Fame for her contributions to Motion Pictures, at 6250 Hollywood Boulevard.

Throughout her professional life, Oberon denied her Indian background but maintained the fiction that she had been born and raised in Australia, specifically in Tasmania. That there were no birth or school records that could prove this, was explained by another fabrication, that they had all been burnt in a fire. She is only known to have been to Australia once, when she agreed to visit Tasmania towards the end of her life. However, she was not seen in public, and she became ill shortly before attending a reception in her honour in Hobart; those who might have been in a position to confirm or disprove her Tasmanian connection were denied the opportunity to meet her and question her. The story of her alleged Tasmanian connections was comprehensively debunked after her death. It was shown to have been created to disguise her mixed-race Indian background. Yet there are still many people in Tasmania who claim to have known her as a child, and will apparently not be convinced otherwise. Unconvinced, however, was Warner Brothers megastar Errol Flynn, a real Tasmanian, who publicly chided Oberon.