It seems that the Windows Phone 7 SDK doesn't support running inside a VM. On Parallels, the entire VM simply crashes when the emulator is starting up.
Around the web, though, a few people have reported that they were able to use it by changing a lot of the VM settings.
What do I have to change to be able to run it? I'm specially interested in Parallels, but VMWare or any other simulator that run on OSX if fine for me!
The WinPhone7 emulator is itself a VM and few (if any) general-purpose VM's will host another VM, which is why it crashes Parallels etc.
If you want to have the emulator run from within a different VM to the one MS provides, then you're into the realm of extracting images, toggling bits and trying to tack it into your VM of choice. Of course, the chances of the emulator then working as expected with no residual issues is as close to nil as makes no difference ;)
As others have said, WP7 is itself a virtual machine. Even if you can get it to run inside a virtual machine like Parallels, the performance will be abysmal. If your computer supports hardware virtualization, the emulator runs really smooth, without it it's very very sluggish. Running it inside another VM will make it even more sluggish - I am guessing to the point that it's unusable.
I know this is not the answer you want to hear, but I would recommend running Windows in Bootcamp, you will have much better experience developing and emulating.
I'm working in VMware Fusion with Expression Blend 4 RC AND the emulator. works like a charm!