The mode of storytelling of literally describing things that are going on in the story which could instead be intimated. Description is often considered blatant by adults; they prefer to discover what's going on by perceiving how a person acts or figuring out what makes a person act that way rather than being told straight out. Hence, this is the alternative to mimesis.
The term is derived from the generalized study of fiction throughout many mediums. In a role-playing game context it means fictional truth within the boundaries of a game.
(Probably better: "Telling" as opposed to mimesis, which is "showing." The diegetic level is the one in which the story is told. The article by Montfort describes IF in terms of diegesis and other concepts from narratology.)
(Diegesis isn't exactly a "theory" and it is from narratology rather than any medium-specific research.)
- A discussion about mimesis and diegesis on the newsgroup rec.arts.int-fiction