Here is what Wikipedia thinks:
Matte paintings are used to create virtual sets and digital back lots. They can be used to create entire sets, or to extend portions of an existing set. Traditional matte painting is done optically by painting on top of a piece of glass to be composited with the original footage. This trick is nearly as old as film itself. The first matte painting was made in 1907 by Norman A. Dawn, who painted for the movie Missions of California.
LINK:
http://www.eyesontutorials.com/articles/5250/1/Matte-painting/Page1.html