Lynch co-wrote the screenplay with Barry Gifford, whose novel served as the basis for Lynch's film Wild at Heart (1990). Lynch conceived Lost Highway after the critical and box office failure of Twin Peaks: Fire Walk with Me (1992), a film adaptation and follow-up to the cult television series Twin Peaks.
Fred Madison, a Los Angeles saxophonist, receives a message on the intercom of his house: "Dick Laurent is dead". During a break at a show one night, Fred calls his home, but his wife Renée does not answer. Arriving home later, Fred finds her sleeping in their bed. The next morning, Renée finds a VHS tape on their porch which contains a videotape of their house. After having sex one night, Fred sees Renée's face as that of a pale old man, then tells Renée of a dream he had about someone resembling her being attacked. As the days pass, more tapes arrive showing the interior of their house and even shots of the pair asleep in bed. Fred and Renée call the police but the detectives offer no assistance.
Fred and Renée then attend a party being thrown by her friend Andy. At the party, the man Fred dreamed about approaches Fred, claiming to have met him before. The man then says he is at Fred's house at that very moment and even answers the house phone when Fred calls it. Fred learns from Andy that the man is a friend of Dick Laurent's. Terrified, Fred leaves the party and heads home with Renée. The next morning, another tape arrives and Fred watches it alone. To his horror, it shows him hovering over Renée's dismembered body. He is sentenced to death for her murder. While on death row, Fred is plagued by headaches and visions of the Mystery Man, a burning cabin in the desert and a strange man driving down a dark highway.
During a cell check, the prison guard finds that the man in Fred's cell is now Pete Dayton, a young auto mechanic. Pete is released into the care of his parents, who take him home and allude to–but never fully explain–his disappearance. Pete is followed by two detectives who are trying to find out more about him. The next day, Pete returns to work at the garage where gangster Mr. Eddy asks him to fix his car. Mr. Eddy takes Pete for a drive, during which Pete witnesses Mr. Eddy chase and beat down a tailgater. The next day, Mr. Eddy returns to the garage with his mistress, Alice Wakefield and his Cadillac for Pete to repair. Later, Alice returns to the garage alone and invites Pete out for dinner. Soon, Pete and Alice begin an affair. Alice fears that Mr. Eddy suspects them, and concocts a scheme to rob her friend Andy and leave town. Alice then reveals to Pete that Mr. Eddy is actually an amateur porn producer named Dick Laurent.
Pete gets a phone call from Mr. Eddy and the Mystery Man, which frightens Pete so much that he decides to go along with Alice's plan. Pete ambushes Andy and accidentally kills him. Pete notices a photograph showing Alice and Renée together, with Alice claiming that she is the blonde woman in the photo. Later, when police are at the house investigating Andy's death, Alice is inexplicably missing from the photo.
Pete and Alice arrive at an empty cabin in the desert, the same one Fred had envisioned. The two start having sex, which ends with Alice getting up and disappearing into the cabin. Pete suddenly transforms back into Fred. Upon searching the cabin, he meets the Mystery Man, who begins filming and chasing Fred with a hand-held video camera, revealing himself to be responsible for the videotapes. Fred escapes and drives to the Lost Highway Hotel, where he finds Mr. Eddy and Renée having sex. After Renée leaves, Fred kidnaps Mr. Eddy, beats him and slits his throat. The Mystery Man then shoots Mr. Eddy dead and whispers something to Fred. The Mystery Man disappears and Fred drives off in Mr. Eddy's car. Fred drives to his old house, buzzes the intercom and says: "Dick Laurent is dead". When the two detectives drive up to the house, Fred runs back to his car and drives off, with the detectives in pursuit. Fred suddenly begins convulsing and screaming as his car speeds down the darkened highway.
Blake, who portrayed The Mystery Man in the film, was responsible for the look and style of his character. One day, he decided to cut his hair short, part it in the middle, and apply white Kabuki make-up on his face. He then put on a black outfit and approached Lynch, who loved what he had done.
Years earlier, Loggia had expressed interest in playing the role of Frank Booth in Blue Velvet (1986). He showed up for an audition, unaware that Dennis Hopper had already been cast, and proceeded to wait for three hours, growing increasingly agitated. Upon seeing Lynch and learning of Hopper's casting, Loggia launched into a profanity-laden rant, which Lynch recalled years later when casting Lost Highway and would eventually become Mr. Eddy's road rage scene.
Lost Highway features the last film performances of Blake, Jack Nance, and Richard Pryor.
Lynch came across the phrase "lost highway" in Barry Gifford's Night People and mentioned to the writer how much he loved it as a title for a film. Lynch suggested that they write a screenplay together. Gifford agreed and they began to brainstorm. Both men had their own different ideas of what the film should be and they ended up rejecting each other's and also their own. On the last night of shooting Twin Peaks: Fire Walk with Me, Lynch was driving home and thought of the first third of Lost Highway all the way up to "the fist hitting Fred in the police station – to suddenly being in another place and not knowing how he got there or what is wrong." He told Gifford and they began writing the screenplay. The two men realized early on that a transformation had to occur and another story developed which would have several links to the first story but also differ. While they were writing the script, Lynch came up with an idea of a man and woman at a party and while they are there another, younger man is introduced who is "out of place, doesn't know anybody there, comes with a younger girl who knows a lot of the people. The girl is actually drawing him into a strange thing, but he doesn't know it. And he starts talking to this young guy who says strange things to him, similar to what The Mystery Man says to Fred Madison." Lynch recalls that the character, "came out of a feeling of a man who, whether real or not, gave the impression that he was supernatural." Gifford describes the Mystery Man as "a product of Fred's imagination" and is "the first visible manifestation of Fred's madness."
According to Lynch, the opening scene of the film where Fred Madison hears the words "Dick Laurent is dead" over his intercom really happened to him at his home. During filming, Deborah Wuliger, the unit publicist, came upon the idea of a psychogenic fugue which Lynch and Gifford subsequently incorporated into the film. Lynch recalls, "The person suffering from it creates in their mind a completely new identity, new friends, new home, new everything—they forget their past identity." Lynch later confirmed to David Sterritt of The Christian Science Monitor that the film does not tell a coherent story.
Lost Highway was shot in approximately 84 days; from November 29, 1995, until February 22, 1996, funded with a moderately large budget of $15 million from the French production company StudioCanal. A vast majority of the film was shot in locations throughout California, in Los Angeles, with the desert scenes being filmed in Nevada. Lynch owns the property used for Fred and Renee's mansion, and designed it himself, along with most of the furniture. The interior shots of the "Lost Highway Hotel" were filmed at the Amargosa Hotel in Death Valley, which is believed to be haunted.
The first cut of the film ran just over two-and-a-half hours. After a screening with 50 people, Lynch cut out 25 minutes of footage, including a scene portraying Renee/Alice's autopsy.
Lynch would later link the film to the O. J. Simpson murder case: a jealous man's state of mind who has indeed committed, and then denies, murder, even to himself.
The film's score was composed by Angelo Badalamenti, with additional music by Barry Adamson.
For years, Trent Reznor had tried to contact Lynch to see if he would be interested in directing a video for his band Nine Inch Nails, but had no success. After his work on the Natural Born Killers soundtrack, Reznor received a call asking if he would be interested in doing the same thing for Lost Highway. Reznor talked to Lynch on the phone and the filmmaker asked if he would also be interested in composing original music for the film. When Reznor agreed, Lynch traveled to New Orleans, where the musician was living, and together they created music that accompanied the scenes in which Fred and Renee watch the mysterious video tapes, a brand new song called "The Perfect Drug," and "Driver Down," a song featured at the end of the film. Reznor also produced and assembled the soundtrack album.
Lynch chose two songs by the German band Rammstein; "Heirate Mich" and "Rammstein." The band based the video for the latter song on this film. The majority of the video is made with clips from Lost Highway.
David Bowie's song "I'm Deranged" was played during the intro and the end credits, in different edit versions, and appears on the soundtrack.
Lost Highway premiered on February 27, 1997 in the United States on a limited theatrical release. The film received mostly lukewarm reviews, with many criticizing the film as obscure in plot or meaningless entirely, but it received praise for its visual aesthetic and the cast's performances. Review aggregator Rotten Tomatoes gives the film a score of 60% based on reviews from 42 critics, with an average rating of 6.1 out of 10. Metacritic, which assigns a weighted average score out of 100 to reviews from mainstream critics, gives the film a score of 52 based on 21 reviews.
Andy Klein of the Dallas Observer considered it superior to Lynch's two previous films: "His most thoroughly surreal work since Eraserhead, this two-hour-plus fever dream is more of one piece than Fire Walk with Me and less desperate and jokey than Wild at Heart." In the Chicago Reader, Jonathan Rosenbaum praised it as "an audacious move away from conventional narrative and back toward the formal beauty of Eraserhead".
Kenneth Turan, on the other hand, wrote, "Beautifully made but emotionally empty, this 1997 release exists only for the sensation of its provocative moments." Gene Siskel and Roger Ebert gave the film "two thumbs down" – though Lynch used this to his advantage by claiming it was "two more great reasons to see Lost Highway", with the 'two thumbs down' used in newspaper ads. Ebert argued, "Lynch is such a talented director. Why does he pull the rug out from under his own films? […] He knows how to put effective images on the screen, and how to use a soundtrack to create mood, but at the end of the film, our hand closes on empty air."
The film was nominated for the Grand Prix of the Belgian Syndicate of Cinema Critics.
In a retrospective review, Jeremiah Kipp of Slant gave Lost Highway three and a half out of four stars and declared that the work "is not an artistic failure; in many ways, it's Lynch at his most daring, emotional, and personal." In 2010, Scott Tobias of The A.V. Club inducted it into the website's "The New Cult Canon" section, viewing it as "more cohesive than it might appear at first blush" and arguing that Lynch "goes digging for truths that people don’t know or won’t acknowledge about themselves—within dreams, within the subconscious, within those impossibly dark hallways where we fear to tread." Tobias also implied that certain plot points in the work may have influenced Michael Haneke's Hidden. Lost Highway later received five votes in the 2012 Sight & Sound critics' poll of the greatest films ever made.
Cultural critic Slavoj Žižek interprets the film's bipartite structure as exploiting "the opposition of two horrors: the phantasmatic horror of the nightmarish noir universe of perverse sex, betrayal, and murder, and the (perhaps much more unsettling) despair of our drab, alienated daily life of impotence and distrust."
In 2003, the film was released on DVD in Canada, through Seville Pictures, in a pan & scan format used for an earlier VHS release. On March 25, 2008, it was released on DVD in the United States, through Universal Studios' Focus Features label, and presented in anamorphic widescreen in the 2.35:1 ratio with Dolby Digital 5.1 audio; it was also released on laserdisc in the same aspect ratio (letterboxed). The film has been released on DVD in Australia numerous times: first by Shock Records in 2001, followed by mk2 in 2007, and again by Madman Entertainment on February 8, 2012.