The first cars produced under the new venture are set to hit Iranian roads in February, with the aim of producing 200,000 vehicles a year by 2018.
PSA is the first Western carmaker to announce a return to Iran since many economic sanctions were lifted in January when a landmark nuclear deal with world powers took effect.
It had signed an initial deal during a visit by President Hassan Rouhani to Paris in January.
"Today is the comeback of PSA to Iran. We are very proud," said Jean Christophe Quemard, who oversees PSA's Middle East and Africa operations.
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The 50-50 joint venture will manufacture three models -- the Peugeot 208, the 2008 sport utility vehicle and 301 compact -- using parts mostly made in Iran.
Some 400 million euros (USD 450 million) will be invested over the next five years, Quemard said at the ceremony, flanked by Iran Khodro chief executive Hashem Yekeh-Zareh.
The money will go into building manufacturing capacity in Tehran, as well as research and development, PSA said in a separate statement.
PSA had to pull out of Iran, its second-largest market, in 2012 when the toughest sanctions were imposed.
Iranian conservatives have been critical of Rouhani's government for restoring trade with PSA and other foreign firms whose departure under sanctions dealt a blow to the economy.
But Industry and Commerce Minister Mohammad Reza Nematzadeh oversaw Tuesday's signing and said more joint ventures were on the way.
"We are optimistic. We hope to hold a similar ceremony for one of Iran Khodro's subsidiaries, Iran Khodro Diesel, with a German company," he said.
PSA also said it was working on new contracts with Iran Khodro regarding the building of older models such as the Peugeot 405 and 206.