The five-year-old, saddled by Mikel Delzangles and ridden by Christophe Lemaire, got home by a nose to win 'the race that stops a nation'.
Lucas Cranach was third in the $6m (£4m) two-mile event watched by 100,000 people at the Australian racecourse.
Last year's winner Americain was a fast-finishing fourth.
It was one of the closest finishes in the 151 runnings of the famous race.
Delzangles said: "I'm still shaking. It's amazing. I thought I was beaten so it's even better.
"It's a great moment for me. This will be one of the great moments of my career."
Continue reading the main story 2011 Dunaden (France) 2010 Americain (France) 2006 Delta Blues (Japan) 2002 Media Puzzle (Ireland) 1993 Vintage Crop (Ireland)Lemaire only stepped in for the ride at the last minute after Craig Williams was ruled out of the race through suspension.
Williams rode Dunaden to win the Geelong Cup in his prep race earlier this month and Delzangles said: "I know it was hard for Craig Williams but it's part of a jockey's life and I know he will win the race one day."
Dunaden is owned by Sheikh Fahad Al Thani under his Pearl Bloodstock banner.
Illo set a steady pace early on with Luca Cumani's Manighar taking up a prominent early position.
The first two were happy to bide their time as Jim Cassidy began to raise the pace a notch at halfway aboard Illo and he headed the field into the straight.
There were plenty in with a chance at that stage but Michael Rodd made his move on Red Cadeaux as Lucas Cranach also began to launch his challenge.
Lemaire then produced Dunaden between the two but Red Cadeaux was still in front coming into the final furlong.
Dunaden was not finished though and he stuck his neck out to just put his head in front on the line.
Continue reading the main story Cornelius Lysaght,BBC horse racing correspondent
What a massive result for the ever-flourishing sporting rivalry between the northern and southern hemispheres as Europe completely dominates the Cup. But also what a real shocker for the locals who managed only one place amongst the main finishers, and that was with a recent import from Germany, Lucas Cranach in third. And it was not as though the international runners sneaked into this most prestigious of handicap races with featherweights, in fact they were mainly saddled with the bigger burdens
Newmarket trainer Dunlop said he was already thinking about a return trip in 2012, adding: "I thought beforehand that he wouldn't like the ground but that was a fantastic run.
"I was watching it with Luca Cumani and he thought I'd got it on the nod, but the best I thought we'd got would have been a dead heat.
"He got a lovely run into the straight and the jockey has given him a great ride.
"We don't like to be second but I've come all the way down here for the first time so you have to be delighted.
"If he's OK, we'll be back next year."
Cumani saddled two in the race with Manighar claiming fifth place while Drunken Sailor was 12th.
Saeed Bin Suroor also fielded two in the race with Lost In The Moment finishing sixth and Modun last of the 23 runners.
Mark Johnston's Fox Hunt was seventh with his other runner Jukebox Jury finishing 20th.
Champion jockey contender Silvestre de Sousa had taken valuable time out from the British title race to ride Fox Hunt.
Brian Ellison was another trainer to be double-handed, but Moyenne Corniche and Saptapadi could muster no better than 15th and 16th respectively.
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