diff --git a/src/compiler/commandLineParser.ts b/src/compiler/commandLineParser.ts
index 94d01e48cf75b..629063de29808 100644
--- a/src/compiler/commandLineParser.ts
+++ b/src/compiler/commandLineParser.ts
@@ -1221,7 +1221,7 @@ const commandOptionsWithoutBuild: CommandLineOption[] = [
     {
         name: "allowArbitraryExtensions",
         type: "boolean",
-        affectsModuleResolution: true,
+        affectsProgramStructure: true,
         category: Diagnostics.Modules,
         description: Diagnostics.Enable_importing_files_with_any_extension_provided_a_declaration_file_is_present,
         defaultValueDescription: false,
diff --git a/src/testRunner/unittests/tscWatch/programUpdates.ts b/src/testRunner/unittests/tscWatch/programUpdates.ts
index cac54dbb52831..14076a2817d1c 100644
--- a/src/testRunner/unittests/tscWatch/programUpdates.ts
+++ b/src/testRunner/unittests/tscWatch/programUpdates.ts
@@ -273,6 +273,48 @@ describe("unittests:: tsc-watch:: program updates", () => {
         ]
     });
 
+    verifyTscWatch({
+        scenario,
+        subScenario: "Updates diagnostics when '--allowArbitraryExtensions' changes",
+        commandLineArgs: ["-w", "-p", "/tsconfig.json"],
+        sys: () => {
+            const aTs: File = {
+                path: "/a.ts",
+                content: "import {} from './b.css'"
+            };
+            const bCssTs: File = {
+                path: "/b.d.css.ts",
+                content: "declare const style: string;"
+            };
+            const tsconfig: File = {
+                path: "/tsconfig.json",
+                content: JSON.stringify({
+                    compilerOptions: { allowArbitraryExtensions: true },
+                    files: ["/a.ts"],
+                })
+            };
+            return createWatchedSystem([libFile, aTs, bCssTs, tsconfig]);
+        },
+        edits: [
+            {
+                caption: "Disable  allowArbitraryExtensions",
+                edit: sys => sys.modifyFile("/tsconfig.json", JSON.stringify({
+                    compilerOptions: { allowArbitraryExtensions: false },
+                    files: ["/a.ts"],
+                })),
+                timeouts: sys => sys.checkTimeoutQueueLengthAndRun(1)
+            },
+            {
+                caption: "Enable  allowArbitraryExtensions",
+                edit: sys => sys.modifyFile("/tsconfig.json", JSON.stringify({
+                    compilerOptions: { allowArbitraryExtensions: true },
+                    files: ["/a.ts"],
+                })),
+                timeouts: sys => sys.checkTimeoutQueueLengthAndRun(1),
+            }
+        ]
+    });
+
     verifyTscWatch({
         scenario,
         subScenario: "updates diagnostics and emit for decorators",
diff --git a/tests/baselines/reference/tscWatch/programUpdates/Updates-diagnostics-when-'--allowArbitraryExtensions'-changes.js b/tests/baselines/reference/tscWatch/programUpdates/Updates-diagnostics-when-'--allowArbitraryExtensions'-changes.js
new file mode 100644
index 0000000000000..1c83b9527c94d
--- /dev/null
+++ b/tests/baselines/reference/tscWatch/programUpdates/Updates-diagnostics-when-'--allowArbitraryExtensions'-changes.js
@@ -0,0 +1,181 @@
+Input::
+//// [/a/lib/lib.d.ts]
+/// <reference no-default-lib="true"/>
+interface Boolean {}
+interface Function {}
+interface CallableFunction {}
+interface NewableFunction {}
+interface IArguments {}
+interface Number { toExponential: any; }
+interface Object {}
+interface RegExp {}
+interface String { charAt: any; }
+interface Array<T> { length: number; [n: number]: T; }
+
+//// [/a.ts]
+import {} from './b.css'
+
+//// [/b.d.css.ts]
+declare const style: string;
+
+//// [/tsconfig.json]
+{"compilerOptions":{"allowArbitraryExtensions":true},"files":["/a.ts"]}
+
+
+/a/lib/tsc.js -w -p /tsconfig.json
+Output::
+>> Screen clear
+[12:00:15 AM] Starting compilation in watch mode...
+
+a.ts:1:16 - error TS2306: File '/b.d.css.ts' is not a module.
+
+1 import {} from './b.css'
+                 ~~~~~~~~~
+
+[12:00:18 AM] Found 1 error. Watching for file changes.
+
+
+
+Program root files: ["/a.ts"]
+Program options: {"allowArbitraryExtensions":true,"watch":true,"project":"/tsconfig.json","configFilePath":"/tsconfig.json"}
+Program structureReused: Not
+Program files::
+/a/lib/lib.d.ts
+/b.d.css.ts
+/a.ts
+
+Semantic diagnostics in builder refreshed for::
+/a/lib/lib.d.ts
+/b.d.css.ts
+/a.ts
+
+Shape signatures in builder refreshed for::
+/a/lib/lib.d.ts (used version)
+/b.d.css.ts (used version)
+/a.ts (used version)
+
+PolledWatches::
+
+FsWatches::
+/tsconfig.json:
+  {}
+/a.ts:
+  {}
+/b.d.css.ts:
+  {}
+/a/lib/lib.d.ts:
+  {}
+
+FsWatchesRecursive::
+
+exitCode:: ExitStatus.undefined
+
+//// [/a.js]
+"use strict";
+Object.defineProperty(exports, "__esModule", { value: true });
+
+
+
+Change:: Disable  allowArbitraryExtensions
+
+Input::
+//// [/tsconfig.json]
+{"compilerOptions":{"allowArbitraryExtensions":false},"files":["/a.ts"]}
+
+
+Output::
+>> Screen clear
+[12:00:21 AM] File change detected. Starting incremental compilation...
+
+a.ts:1:16 - error TS6263: Module './b.css' was resolved to '/b.d.css.ts', but '--allowArbitraryExtensions' is not set.
+
+1 import {} from './b.css'
+                 ~~~~~~~~~
+
+[12:00:25 AM] Found 1 error. Watching for file changes.
+
+
+
+Program root files: ["/a.ts"]
+Program options: {"allowArbitraryExtensions":false,"watch":true,"project":"/tsconfig.json","configFilePath":"/tsconfig.json"}
+Program structureReused: SafeModules
+Program files::
+/a/lib/lib.d.ts
+/a.ts
+
+Semantic diagnostics in builder refreshed for::
+/a.ts
+
+Shape signatures in builder refreshed for::
+/a.ts (computed .d.ts)
+
+PolledWatches::
+
+FsWatches::
+/tsconfig.json:
+  {}
+/a.ts:
+  {}
+/a/lib/lib.d.ts:
+  {}
+
+FsWatchesRecursive::
+
+exitCode:: ExitStatus.undefined
+
+//// [/a.js] file written with same contents
+
+Change:: Enable  allowArbitraryExtensions
+
+Input::
+//// [/tsconfig.json]
+{"compilerOptions":{"allowArbitraryExtensions":true},"files":["/a.ts"]}
+
+
+Output::
+>> Screen clear
+[12:00:28 AM] File change detected. Starting incremental compilation...
+
+a.ts:1:16 - error TS2306: File '/b.d.css.ts' is not a module.
+
+1 import {} from './b.css'
+                 ~~~~~~~~~
+
+[12:00:32 AM] Found 1 error. Watching for file changes.
+
+
+
+Program root files: ["/a.ts"]
+Program options: {"allowArbitraryExtensions":true,"watch":true,"project":"/tsconfig.json","configFilePath":"/tsconfig.json"}
+Program structureReused: SafeModules
+Program files::
+/a/lib/lib.d.ts
+/b.d.css.ts
+/a.ts
+
+Semantic diagnostics in builder refreshed for::
+/a/lib/lib.d.ts
+/b.d.css.ts
+/a.ts
+
+Shape signatures in builder refreshed for::
+/b.d.css.ts (used version)
+/a.ts (computed .d.ts)
+
+PolledWatches::
+
+FsWatches::
+/tsconfig.json:
+  {}
+/a.ts:
+  {}
+/a/lib/lib.d.ts:
+  {}
+/b.d.css.ts:
+  {}
+
+FsWatchesRecursive::
+
+exitCode:: ExitStatus.undefined
+
+//// [/a.js] file written with same contents