The effect of localized surface plasmon resonance of Ag nanoparticles on the diffraction efficiency of holographic polymer dispersed liquid crystal grating (H-PDLC) is reported. The surface plasmon resonance characteristic of spherical Ag nanoparticles within the PDLC material is analyzed. According to Mie theory, the extinction spectra of spherical Ag nanoparticles surrounded by PDLC material are simulated and then the resonance wavelength is found in the extinction spectra, which is very similar to the resonance wavelength value measured by spectrometer. In addition, the electric field distribution inside and outside the spherical Ag nanoparticles is simulated according to quasi-static approximation method. It is testified that Ag nanoparticles exhibit surface plasmon resonance in the PDLC material during holographic recording process, thus the phase separation between liquid crystal and polymer is significantly improved and the grating structure is much smoother than the sample without Ag nanoparticles, which greatly increases the diffraction efficiency of H-PDLC grating.