Polymer matrix type chitosan-silver nanocomposite containing different weight percentage of silver was synthesized by the chemical method. HRTEM images confirm the embedment of silver in the chitosan matrix. The binding of silver to the NH2 and OH groups of chitosan is evident from XPS and FTIR studies. An increase in the absorbance observed from UV–Vis analysis on raising the weight percentage of silver showed the increase in the amount of silver in the nanocomposite. The face centered cubic structure of silver and the semi-crystalline nature of chitosan are evident from the XRD studies. On interaction with mercury the UV–Vis spectra of the composite showed a decrease in intensity and a blue shift confirming the use of the composite as a colorimetric sensor for the detection of mercury. The limit of detection was found to be about 7.2×10−8M. High specificity and the sensitivity of the environmental friendly and non-toxic nanocomposite to detect very low concentrations of mercury make the system a perspective one.