Arc faults threaten the safe operation of photovoltaic (PV) systems. An arc fault detection and localization approach using parallel capacitors is proposed. A PV system has been analyzed and tested with five capacitors paralleled with the branches in the system. Series and parallel arc faults at nine locations have been tested in the system. When an arc occurred, current pulses were generated in the capacitors and their amplitudes and polarities were obtained through Hall current sensors. Discrete wavelet transformation was performed on the capacitor currents and the distributions of their amplitudes, frequency spectrums, and polarities are here reported. The results indicate that the distributions are unique under different fault types and locations, which could be used to detect and localize arc faults in PV systems. Moreover, the amplitudes of the capacitor currents can also help to localize a series arc fault within a PV string. Finally, the proposed approach is validated by a double-fault test.