The diegesis (or "fiction", "fictional world") is the world of things that are true to the character - as opposed to the player - at a larp. Players at a larp usually pretend that their characters inhabit the same diegesis, i.e. if it is true to Hamlet that England exists in this world then it is also true to Claudius.
Things that are true within the world the character inhabits are called "diegetic", while things that are only true to the player are called "non-diegetic". For example: a knight battles a dragon at a larp. The dragon is invisible, imagined by the player, and entirely diegetic. The armour worn by the knight is true both to the character and player, and hence both diegetic and real, while the boffer sword is a representation of a diegetic metal sword. The pompous modern music playing in the background of the battle is entirely non-diegetic.
While players pretend their characters inhabit the same diegesis, this is a necessary illusion - no player can observe what the other players imagine, and hence diegeses are subjective and often inconsistent.
The concept has been used in Nordic larp theory to discuss questions such as the appropriate uses of music in larp, and what is really going on when people role-play. Most definitions of larp and role-playing use the concept.