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Yitzhak Rabin and Yasser Arafat put their names to the 400-page agreement in a low-key ceremony in the East Room of the White House.
They were watched by US President Bill Clinton, Egypt's President Hosni Mubarak and King Hussein of Jordan.
The leaders of Syria and Lebanon were conspicuous by their absence. Mr Rabin and the US president both called on the two Arab nations to resume peace talks with Israel.
The event, which President Clinton hailed as "a new chapter" for the Middle East, was almost derailed by a last-minute disagreement between Mr Rabin and Mr Arafat over policing arrangements in the West Bank town of Hebron. It was resolved just hours before the signing ceremony.
Mr Rabin urged the PLO to resist "the evil angels of death by terrorism" determined to destroy the peace process.
Israel's foreign minister, Shimon Perez, welcomed the deal saying, "Once implemented, no longer will the Palestinians reside under our domination. They shall self-rule and we shall return to our heritage."
Mr Arafat declared there had been "enough killing of innocent people" calling the deal a "peace of the brave" - but he acknowledged it would be opposed by many.
Following the landmark Oslo agreement of September 1993, also brokered by the Clinton administration, Gaza and the West Bank town of Jericho were handed over to Palestinian rule.
But suicide bombings in Israel by Hamas extremists have continued and after each attack Israel closes its borders to Arabs living in Gaza and the West Bank.
Migrant labour is the backbone of the Gaza economy and every closure is a severe financial blow to Palestinians - and the credibility of Mr Arafat as a leader in the eyes of his people.
For this reason Palestinians are not enthusiastic about the new deal, known as Oslo 2, and are sceptical of the chances for long-lasting peace.
From his side, Mr Rabin faces strong opposition from the right-wing Likud party and from Jewish settlers, especially those who live in or near Hebron.
The settlers believe the West Bank - occupied by Israel since the 1967 war - is part of territory handed to Abraham and the Jews by God.
It is expected that the agreement will be passed by a narrow majority in the Israeli parliament (Knesset) next week.
But security experts estimate half of the 140,000 settlers will resist any attempt to evict them and will try to obstruct the deployment of armed Palestinian police in Hebron.
Under the agreement, six Arab cities, including the commercial capital of Nablus, will be transferred to Palestinian rule along with 60% of Hebron.
Israel will also give up police and civil powers in a further 450 Palestinian towns and villages. However it will retain military power there and the Israeli Army will still control 70% of West Bank land overall.
There will also be a phased release of Palestinian prisoners.
Palestinians will also elect an 82-member Council and an executive head.
Just over a month later Yitzhak Rabin was assassinated by a Jewish extremist on 4 November 1995.
Shimon Peres pushed on with Mr Rabin's efforts to make peace with the Palestinians.
But in the 1996 election he lost to Binyamin Netanyahu who campaigned against the Rabin-Peres peace programme.
Suicide bomb attacks against Israelis and military counterattacks in Palestinian strongholds heightened tensions between the two sides again and peace talks kept stalling.
In February 2000 Yasser Arafat turned down a peace deal offered at Camp David by President Clinton and Israeli PM Ehud Barak.
Israel ended its involvement in Lebanon in May 2000.
But in September that year, opposition leader Ariel Sharon made a controversial visit to the Al Aqsa mosque compound in east Jerusalem, a site which is also holy to Jews.
Critics say Mr Sharon knew the visit would trigger the ensuing violence between Palestinians and Israeli forces and gambled on the Israeli public turning to a tough leader like him who would know how to handle it firmly.
0n 6 February 2001 he won a landslide victory, pledging to achieve "security and true peace" while insisting he would not be bound by previous negotiations with the Palestinians.
In June 2002 following a series of suicide bombings, work began on building a security wall, 640 km (440 miles) long, between Israel and the West Bank.
An effort to revive the peace process resulted in the publication of a new roadmap for peace in April 2003.
Mr Arafat died in November 2004.
In August 2005 Israel began implementing a Disengagement Plan by evicting all settlers from Gaza and some areas of the West Bank.
Palestinian officials have for some time expressed the fear that disengagement is a ruse to cement Israeli control over much of the West Bank.
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