Mismatch repair (MMR)-deficient cancers are characterized by microsatellite instability (MSI) and hypermutation. However, it remains unclear how MSI and hypermutation arise and contribute to cancer development. Here, we show that MSI and hypermutation are triggered by replication stress in an MMR-deficient background, enabling clonal expansion of cells harboring ARF/p53-module mutations and cells that are resistant to the anti-cancer drug camptothecin. While replication stress-associated DNA double-strand breaks (DSBs) caused chromosomal instability (CIN) in an MMR-proficient background, they induced MSI with concomitant suppression of CIN via a PARP-mediated repair pathway in an MMR-deficient background. This was associated with the induction of mutations, including cancer-driver mutations in the ARF/p53 module, via chromosomal deletions and base substitutions. Immortalization of MMR-deficient mouse embryonic fibroblasts (MEFs) in association with ARF/p53-module mutations was ~60-fold more efficient than that of wild-type MEFs. Thus, replication stress-triggered MSI and hypermutation efficiently lead to clonal expansion of cells with abrogated defense systems.