What I've assumed — and also read — all along since the first time I watched it was that Diane projected herself as Betty and her lover Camilla as Rita. After watching again last night I'm almost fully convinced this isn't the case. I think Diane is really dreaming of herself as Rita, and that Camilla is assuming the role of Betty in Diane's dream. Here's why.
Diane is completely in love with Camilla. She meets this wonderful, beautiful woman when she comes to Hollywood, who befriends her, and despite beating her out on a big role, there's an admiration there. Camilla gets the attention of the movie moguls. She draws the eye of Adam Kesher. She's the one who's beautiful and irresistible — all those things Diane wants to be herself. So she projects herself in that role, and Camilla assumes the role of Betty.
The attempted assassination of Rita occurs just as Diane's trip up to Kesher's party transpired. The car takes a long, winding journey up Mulholland Drive and suddenly stops in the middle of the road. In reality, Camilla emerges from the side of the road and escorts her up a back way to the property — in the dream it's where the driver pulls the gun on her. This is why she knows this scenario so vividly and projects the same drive and sudden stop as "Rita's" assassination attempt — because Diane experienced it herself.
In the shower when Betty asks her name, Rita doesn't know. If Diane is projecting herself as Rita, it makes sense that she can't remember her own name or identity. She's repressing who she is and what she's done in real life. In her dream she doesn't want to confront who she is and what she's done: plan Camilla's murder.
Why is the money in Rita's possession and not Betty's? This is the same blood money that Diane uses in real life to pay the hitman. So now Rita can't remember her name and is in possession of this money and can't remember why. Consider that Diane is Rita, and is repressing both her identity and the real reason she is carrying this money.
When the clairvoyant comes to the door and speaks with Betty, she questions where the aunt is. Betty says she's the niece and is staying there. The clairvoyant says "That's not who you are," confronting Betty that she's not who she says she is. But more importantly, right when Coco is starting to drag her away from the door, the old woman peers in and catches a glimpse of Rita right as she says "someone's in trouble." Perhaps the inference is that Diane — projected as Rita — is in trouble for what she's done.
When Betty goes for her audition and is just about ready to start the scene with her male co-star, the actor looks over at the director and says "Play it close like we did last time — you know, the one with the black hair — what's her name?" Since this is Diane's dream and in reality Diane actually lost out on the part to Camilla, Diane is that nameless, forgotten dark-haired woman he's referring to. And Betty is the talented, beautiful Camilla, who comes in and gives a knock-out performance and gets the part.
Just as they finish reading their lines and the room erupts in applause, the casting director takes Betty over to Adam Kesher's set. Everything is in slow motion as the lady singers audition. As Betty walks onto the sound stage, Adam's head inexplicably turns — and their eyes meet and lock. In reality this love happens between Adam and Camilla, further suggesting that Betty is the embodiment of Camilla rather than Diane. Diane never drew Adam's attention, but Camilla did.
Rita is the one who "remembers" the name Diane Selwyn, not Betty. This would make sense: as the dream wears on, the illusion of Diane's repression begins to fade and slowly her reality is reintroduced. Seeing the name "Diane" on the waitress's name tag at Winkie's starts this process. Also notice that when the two women are at Winkie's, Rita is sitting where Diane later sits when she meets with the hitman.
When the women arrive at Apt. 12 and the neighbour says that Diane now lives in Apt. 17, it preserves the illusion for Rita a little longer. There's almost relief on her face — as if to suggest that being Diane is something she doesn't want for some reason.
When Betty and Rita enter the bedroom in Apt. 17 and discover the body of Diane, it's Rita who reacts by breaking down, almost collapsing into Betty's arms. It's Rita who reels and lets out a loud gasp when the neighbour knocks on the door — not unlike how Diane herself will react to the knock prior to her suicide.
In the very next scene, Rita is found cutting her hair wildly in the sink, getting rid of the long locks that make up her "false" identity. Betty stops her and says "I know what needs to be done — let me help you." The next shot is the two of them standing side by side in the mirror, Rita wearing a blonde wig the same style, cut, and colour as Diane's. The illusion is fading, and Rita is discovering the truth about who she is.
When they arrive home, it's the blonde-clad Rita who turns to get the key to unlock the blue box. When she turns around, Betty is gone. Reality is rushing back, and with the turn of a key, she begins to wake up.
The Cowboy peers in the bedroom, where a woman is lying in bed in her ultimate death pose. The image is a blonde wearing a black dress — the same as Rita had worn to the theatre that night (Betty was wearing a red top). It's Rita's image that the Cowboy looks in on just as reality comes back into focus.
After Diane's neighbour collects her things, Diane turns her head to the left and says "Camilla, you've come back" — the camera cuts to a shot of Camilla standing there smiling. Then it cuts back to Diane's happy surprise, which changes suddenly. Her eyes widen, her face twists with disgust. The camera cuts back to where Camilla had been — and looking back at her is herself.