I'm sure this quastion's been asked many times before, but I couldn't find the answer on official Bethesda support and I've seen different answers on different TES-related forums on the Internet. Is it actually physically possible to walk between cities/towns/etc. in Arena?

I don't think so. The wilderness is procedurally-generated and infinite (I heard somewhere that after a LONG time, it starts to repeat itself).

Yeah, what Orcsbreath said. You need to use fast-travel to travel between the cities.