Research on auditory verbal hallucinations (AVHs) indicates that AVH schizophrenia patients show greater abnormalities on tasks requiring recognition of affective prosody (AP) than non-AVH patients. Detecting AP requires accurate perception of manipulations in pitch, amplitude and duration. Schizophrenia patients with AVHs also experience difficulty detecting these acoustic manipulations; with a number of theorists speculating that difficulties in pitch, amplitude and duration discrimination underlie AP abnormalities. This study examined whether both AP and these aspects of auditory processing are also impaired in first degree relatives of persons with AVHs. It also examined whether pitch, amplitude and duration discrimination were related to AP, and to hallucination proneness. Unaffected relatives of AVH schizophrenia patients (N = 19) and matched healthy controls (N = 33) were compared using tone discrimination tasks, an AP task, and clinical measures. Relatives were slower at identifying emotions on the AP task (p = 0.002), with secondary analysis showing this was especially so for happy (p = 0.014) and neutral (p = 0.001) sentences. There was a significant interaction effect for pitch between tone deviation level and group (p = 0.019), and relatives performed worse than controls on amplitude discrimination and duration discrimination. AP performance for happy and neutral sentences was significantly correlated with amplitude perception. Lastly, AVH proneness in the entire sample was significantly correlated with pitch discrimination (r = 0.44) and pitch perception was shown to predict AVH proneness in the sample (p = 0.005). These results suggest basic impairments in auditory processing are present in relatives of AVH patients; they potentially underlie processing speed in AP tasks, and predict AVH proneness. This indicates auditory processing deficits may be a core feature of AVHs in schizophrenia, and are worthy of further study as a potential endophenotype for AVHs.