The answer I develop here is along the lines of the general existential-phenomenological psychopathological scheme I've been developing for understanding psychoses.
The general strategy of this scheme is to explain an abnormal perception in terms of a skewed prior 'expectation' sedimented in the lived body, or, to put it differently, a skew in the fabric of the body schema. The skewed expectation is nothing conscious and does not belong to thought. Rather it belongs to the fabric of the apparatus of thought and experience.
In cases in which someone sees themselves as somewhere or other grossly fat (despite the fact that they are in this area really tiny), what has happened is that their tacit body-schema-embedded 'sense' of what they can expect to meet with in self-perception is aetiolated.
When I say 'sense' or 'expect' I'm speaking somewhat metaphorically. I'm not talking about the body image (i.e. our inner picture of what we are like), and not talking about anything thought or experienced by the person. Rather I'm talking about those tacit embodied expectancies that go to make up corporeal selfhood. The principle function of these is to coordinate our experiences of those others and those objects with whom and which we are in sensori-motor interaction. (This highly contrastive distinction between personal-level body image and sub-intentional body schema is owed to Shaun Gallagher.)
It is the contrast between the aetiolated tacit 'sense' of self and the reality of the fairly normal sized person in the mirror which gives rise to the illusion of hugeness.
Anaologies may help. We are all familiar with times when we get used to something rather extreme and then, when confronted by a regular sized item, take it to be rather small. Living with a fat domestic cat will do this to one's perception of the cats of others. Or: I take a flexible tape measure out in the heat, and it expands, and what it measures will now measure as smaller than when it was at room temperature. Or, when on an escalator my body gets used to the forward movement and then, although when we arrive at the top we are just walking onto something static, we lurch as if we had encountered something moving. In this last example the expectancies or senses that constitute the body schema have altered.
This, I am claiming, is what we meet with in dysmorphophobia. If the measuring stick of the body schema has shrunk, the experience in the mirror of the offending item - the nose, the stomach, the thighs, etc. - the body image - will now appear huge. The illusion of fatness is generated by the mismatch between the tacit body schema and the perceived body.
Any perception is a function of the body schema's 'expectation' plus sensory stimulation. (Mathematical analogy: Receive sensory stimulation of +2, be expecting -4, and the resulting perception will be -2.) Keep your head and body still, you 'expect' the world to be still; yet unexpected sensory stimulation occurs: perception results: the hawk now sees the mouse. (Perception, remember, is in no sense a straightforward function of sensory stimulation, but rather depends also on a combination of the body's movement, the sensory organs' movement, the body's 'expectation' of what sensory stimulation changes will occur with this movement, etc. etc.) And what I am claiming in cases of distorted body image and body perception is that the source of the skew is a disturbance in the field of expectations sedimented in the lived body, expectations that constitute the body schema.
I want to stress how important it is to grasp that the 'sense of self' embedded in the body schema is precisely the opposite of what is actually experienced by the self. The psychologist sometimes explains hallucinations in terms of someone seeing what they expect or want to see. On my theory this is precisely wrong. They are not really expecting or wanting to see anything; rather the hallucinator is seeing the opposite of what their lived body 'anticipates'. This is why Gallagher's distinction between body image and body schema is 100% crucial.
Why is it that the body schema becomes aetiolated and the body image therefore becomes gross? One possible cause could be physical abuse - intrusive touching. The body schema - what goes to constitute corporeal selfhood - defensively pulls back within the lived body, jettisoning as extrinsic to itself aspects of the body's fleshliness. This would explain the way in which flesh is typically re-described as 'fat' (i.e. blubber), as something extrinsic to the self, as some unwanted accretion parasitically hanging off the true inner self. The experience of intrusive touch is an experience of disgust, and when this cannot be tolerated - i.e. when the toucher cannot be kept out from, separated from, the touched - the body schema chooses self-sacrifice. Another cause may be a wish to renunciate puberty. The body schema refuses to budge; perhaps rather small hormonally-inspired changes in body shape now register as gross.
Patients with dysmorphophobia may spend a lot of time looking in the mirror at their putatively greatly distended nose or what have you. As one looks and prods more and more, the body schema may defensively retreat further from the nose, and this in turn naturally (and in fact necessarily) drives an enlargement of the nasal body image. The preoccupation, the disgust-driven disidentification, and the illusion of grossness, may all be of a self-ratcheting piece.
Such self-sacrifice of the body schema may also be theoretically equivalent to what in psychoanalysis would be called a form of projective identification. The problem with the use of the defense is that it preserves a sense of going-on-being(-just-the-same) at the cost of a continued experience of persecution. Persecution, now, by one's own fat. That will always be the price of a body schema that does not incoorporate all of the body within it. The putatively alien part will adhere in a way felt disgusting and horrific.
It would explain too how those with body dysmorphia can become highly defensive and sensitive when we touch on these matters. The aetiolation of the body schema is doing powerful defensive work.