Objective: The authors investigated impaired differentiation of limbic-prefrontal systems by autonomic arousal in schizophrenia. It was predicted that paranoid patients would be distinguished by a disjunction of hyperarousal but reduced amygdala and medial prefrontal activity relative to both healthy comparison subjects and patients with nonparanoid schizophrenia. Method: Pictures depicting facial expressions of fear were presented to 27 schizophrenia patients (13 paranoid, 14 nonparanoid) and 22 matched healthy comparison subjects in an implicit perception task to evoke limbic activity. Simultaneous functional magnetic resonance imaging and skin conductance arousal recordings were acquired during presentation of faces expressing fear or neutral emotion. Responses to fear stimuli were further examined by contrasting those that were associated with a skin conductance response (“with arousal”) and those that were not (“without arousal”). Results: In the comparison subjects, arousal dissociated amygdala/medial prefrontal (“visceral”) networks and hippocampus/lateral prefrontal (“context”) networks for fear perception. Excessive arousal responses were elicited in the schizophrenia subjects, but there was an associated reduction in amygdala/medial prefrontal activity. This disjunction was pronounced in paranoid patients relative to both healthy subjects and nonparanoid patients. Paranoid patients also showed a relatively greater prefrontal deficit for “without-arousal” responses. Conclusions: This is the first study to reveal a functional disconnection in autonomic and central systems for processing threat-related signals in patients with paranoid schizophrenia. Paranoid cognition may reflect an internally generated cycle of misattribution regarding incoming fear signals due to a breakdown in the regulation of these systems.