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,
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.