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Matt Brown, a state minister in New South Wales, admitted he had made a "mistake" and was "embarrassed".
He strongly denied local press reports of lewd conduct with a female staff member, who has also denied the allegations.
State Premier Nathan Rees said there had been too many reports of Mr Brown in his underwear to ignore.
Reports of the raucous party in Mr Brown's Parliament House office, surfacing in local newspapers, alleged the minister had danced in "very brief" underpants to techno music on a green couch.
The party occurred three months ago when Mr Brown was state housing minister, and was to celebrate the budget.
Initially Mr Brown said nothing untoward had happened at the party. But his boss, Premier Rees, was not so sure.
"I subsequently put it to former minister Brown late last night that there are too many reports of you in your underwear for me to ignore.
"He conceded he'd been in his underwear and that gave me no option but to demand his resignation," Mr Rees told Fairfax Radio Network.
Mr Brown then admitted conduct unbecoming to a minister, and resigned only three days after being sworn into office as minister for the police.
"I'm a human being and I made a mistake and I'm going to cop the consequences of that mistake," Mr Brown told reporters, without elaborating.
A former lawyer and university lecturer, Mr Brown had been a state lawmaker for nine years. His political future remains unclear.
(BBC)
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