There is a philosophical problem called the mind-body problem. Basically, it is about the nature of human mind: Is it physical, emergent from what is physical, or entirely separate? If separate, how does it connect to the body? This piece of setting metaphysics is somewhat influenced by that problem.
Originally I developed these as a metaphysical structure for my traditional fantasy setting, the current form of which is not written down anywhere. Some assumptions: Certain sorts of magic are at least possible. There are spirits everywhere; that is, animism is correct. Dragons are the most mighty creature there is by their nature.
The three realms
The reality is neatly divided into three level, or dimensions, or planes, realms, or whatever name is desired for them. Some creatures only exist on specific levels, others are defined as the places where the levels interact.
The physical level, realm of body, is much like the physical world around us. The world may be a planet, or a disc riding atop elephants riding on a turtle swimming around space, or the world may be an infinite plane, or whatever. The physical realm is associated with persistency and stability; if something exists on the level of body, removing it without a trace is difficult.
The realm of dream is where emotions, ambitions, inspiration and dreaming happen. It is an ever-changing realm where distance is determined by familiarity and will; know something and it is easy to find, and it will have easy time finding you. Those with strong will can mold the dreaming with little trouble. Spirits, fey, demons and angels (all are the same thing) are creatures of the dreaming. All emotions and feelings live in the dreaming, and like attracts like; if one sleeps and is afraid, something that lives off, enjoys, or is fear may be attracted.
One moves in the dreaming by wanting to be somewhere. Walking, closing one’s eyes, or other such gesture often helps travelling; people are not used to their environment changing with little warning, and being panicked in the realm of fae is a definite risk; those attracted by panic tend to not be friendly and helpful. A person is sad when the region around the person contains much sadness; likewise, the surroundings of a sad person will become sad. The power of these interactions is determined by the strength of will of those involved.
The mental level, realm of mind, is where all knowledge and experience is. It is an immense, mayhaps infinite, collection of knowledge. When person thinks something, he is in the corresponding part of the realm of mind. Learning something means finding, or building, quick paths and ways between regions of the mental realm. One can likewise construct barriers and drive entities away from certain regions, though they are by no means simple tasks.
The human nature
Humans are creatures that connect all the three realms, yet have difficulty focusing on more than one at a time. Human presence drifts between the three realms. When the presence is in the physical realm, humans can be skilled athletes, precise craftsmen, or careful observers. When the presence is elsewhere, body does what it should be doing; keeps walking, is inactive, remains in one place, relaxes, is paralysed.
One’s presence is on the level of dream if one is feeling a strong emotion or sleeping. One who is friendly inspires others around him to act in a friendly way; one who is depressed provokes negative reactions. The confidence of a leader makes those around her confident of their abilities. Persuading or threatening someone means pushing one’s will and dreams against theirs until they give up. Intimidation is the brute force version; persuasion means emphasising their emotions that already agree with out while dampening the parts that do not. People in shock cut the dreaming away from themselves so as to not feel the pain. So do those who deny some emotionally powerful thing.
Presence in the mental realm indicates deep thought, perhaps solving a problem, trying to remember something, learning or communicating. Recalling means trying to find the lost pathway, while learning and solving problems is the process of discoring or constructing new ways, respectively. Communication is trying to describe some landmarks and guidelines so that the other person might find a way to the desired region of the mental level. Person who is quick-witted has fast methods of getting to the desired place. Someone who is intelligent can has discovered powerful methods of finding new paths. People who know a lot have mapped large areas of the realm. When one’s presence is not on the level of mind, deep thought does not happen.
Inanimate objects have a very alien presence on the mental realm (some would say very limited), to such extent that communication with them is next to impossible. Their emotional presence can be strong. Old forests are peaceful, because the trees are calm; at night they can be menacing, for the trees do not enjoy the fire in their midst. The sense of wonderment that natural wonders can evoke is another effect of their significant emotional presence.
Most animal, likewise, have fairly strange ways of thinking. Many mammals are so alike people that rudimentary communication, or at least one-way understanding, is possible.
The denizens of dreaming are known by many names: Angels, demons, spirits, fey. Their physical presence varies from none through normal everyday object and animals to unique forms. Their mental presence likewise varies from sapient to mere instincts that the nameless spirits have. Even the least of feykind can mold the dreaming wtih great ability; the most pitiful imp has little trouble tricking an average dreamer (that’s why nightmares are common). The powerful lords of the dreaming can incite bloody rebellions or even wars with their mere presence.
Dragons are unique in that their presence never really leaves any realm. Dragon does not merely wonder about your name; its mental presence makes you want to say it out loud and when you do, it is already listening at you. Dragon does not merely try to eat you; when it bites at you, you willingly jump into its mouth and it has additionally determined your possible reactions, as well as how it will respond to each. An angry dragon flying overhead creates a storm by provoking the spirits of clouds and air; people will flee, faint, or kill each other. (Younger dragons are less powerful, but only in scope and force of the effect.)
The original setting metaphysics were a mess similar to Platon’s ideas. It did not work well because there existed a god of fire, of mountains, of a vulcano, of lava, of heat, … Most of them were mere disembodied spirits, some were dragons, the most powerful actual gods. It became too much of a mess to understand.
That there are three realms is a matter of design history; the original had at least dreaming and physical world. Neither of those worked like deep thinking does, so I decided for it to be the third one. This is somewhat similar to BESM, actually, which I disliked way back then because it had only three stats (all strong people are also dexterous, for example).