As a valuable medicinal herb and spice, agarwood is widely used in the fields of daily chemistry, traditional medicine, religion and literary collection. It mainly contains sesquiterpenes and 2-(2-phenylethyl)chromones, which are often used to soothe the body and mind, relieve anxiety, act as an antidepressant and treat insomnia and other mental disorders, presenting a good calming effect. This paper reviews the chemical composition of the essential oils of different sources of agarwood, as well as the progress of research on the sedative and tranquilizing pharmacological activity and mechanism of action of agarwood essential oil (AEO), and then analyzes the current problems of AEO research and its application prospects in the treatment of mental diseases.