Not hallucination, but ghosts. That would be closer to the fantasy theme.
"cough"illusion magic"cough"
We have a whole school of magic based on effecting your enemy's mind/senses and creating/disrupting/redirecting light.And everything else that the word illusion might justify.
Besides,those unique quests are always some of the funnest.I'm sure most of the people here remember Arkved's nightmare tower.Or the dark brotherhood mission where you set the party guests against each other.