The two groups will invest around 300 million euros ($404 million) in diesel engines compatible with Euro-6 for use in commercial vehicles and cars, they said in a joint statement on the eve of the Paris Auto Show.
The first engines will go into production in 2013.
The two groups have worked together for 10 years on diesel engines.
Carmakers worldwide are looking to sign new partnerships or firm up existing ones as they seek synergies from sharing development costs and access to lucrative new markets.
PSA also has a partnership in place with Japan's Mitsubishi Motors Corp on electric vehicles and 4X4s.
They announced an agreement on Wednesday to develop electric versions of the Peugeot Partner and Citroen Berlingo light commercial vehicles in PSA's factory in Vigo, Spain.
PSA also works with Italy's Fiat and Japan's Toyota.
(Reporting by Gilles Guillaume; Writing by Helen Massy-Beresford; Editing by James Regan and Hans Peters)