I'm not completely sold on new theory in LP's link. I've got my own hypothesis on the cause of the Moon illusion.
I only notice the Moon illusion at full moons. It is my experience that others share this perception. Many times I've heard someone say "look how large the Moon is!", or "did you see the Moon last night, it looked so large". These statements have always referred to a full moon on the horizon.
So, what's going on?...
I once got a "3x telescope" from a box of Cracker Jacks. Trying out my new toy, I first assumed I was looking through the wrong end because things appeared smaller, not bigger. But I was holding it right. Keeping my other eye open, I could confirm that objects through the telescope were indeed 3x bigger. But they weren't clearer: ie, if I was trying to read the words on a sign 20 meters away, I had a better chance of doing it naked-eye, rather than with the 3x telescope. Because of its cheap plastic lens, you actually lost detail despite gaining size. And this tricked my mind into thinking that the telescope actually made things look smaller.
When the full moon is high in the sky, at first glance, it is completely over exposed to my eyes. I can't see any detail. After staring at it, my pupils closed down, and some detail comes into view, but the high contrast between the Moon and the surrounding sky still seems to rob the Moon of detail. But on the horizon, the atmosphere will blur the Moon a bit, but it also dims it to the point that surface detail is easier to see, especially when it is against a sky that is not yet completely dark. So at first glance, its much easier to differentiate the dark fields from the bright highlands when the Moon is on the horizon rather than when its high in the sky. And based on my "3x telescope" observation, more detail means things appear larger.
Furthermore, I don't seem to notice the Moon illusion on waxing gibbous moon rises, when the Moon rises while the Sun is still up. At this point I think the atmosphere robs the Moon of contrast, making detail more difficult to see, negating the moon illusion.
I also think that a full moon, high in the sky, when viewed through clouds looks larger than when viewed through a break in the clouds. The clouds act as a filter, cutting the glare and allowing me to see more detail. The same is true for the Sun. Sometimes the clouds are the right thickness so that you can perceive the Sun as a round circle in the sky. That's what stands out to me is how round and large the Sun is. I don't get that impression when glancing at the Sun high in a cloudless sky.
If my hypothesis is correct, here's a simple experiment I'd like to perform (except it's usually cloudy here on full moons): Have a group of people view the full moon on the horizon and sketch what they see. A few hours later have the people sketch the Moon again (preferably this would be a different group of people who aren't biased by detail they memorized from their first drawings). Compare the two groups of drawings. Which has more detail?
