One of my favorite classes in college was Play Therapy. I am not currently working in play therapy- but as a Mom of small kids I constantly see how healthy, therapeutic play can help young minds process emotions and information they experience on a daily basis.
Example: My son watched a cartoon called Chuck & Friends, a story about a little dump truck that has fun building race-car and monster truck tracks.
Next thing I know my son is building race-car tracks from wooden train tracks and my kitchen utensils :)
He was experimenting with gravity, velocity, cause & effect, etc.
His mind was processing some of the race-car events and reactions he saw on Chuck & Friends.
I also see my children experimenting with their emotions, processing what they have experienced through role-play and imaginary characters.
Sometimes I ask my children to draw or describe some of their own make-believe characters. One day my kids got on a rainbow-people kick:
My son kept talking about a Fireman Captain that has rainbow hair, wears a rainbow jacket, and has a rainbow dog. The captain has a huuuuuge family. He always loves rainbows and he is so, so nice!
My daughter (3 yrs) imagined a Fire-girl Chief with rainbow hair and a rainbow unicorn. The chief lives in a rainbow city on a rainbow-colored road. She feeds, cares for and plays with her unicorn all the time.
Creating back stories for characters help children explore the multifaceted complexities of a human personality. In real life, the people we meet are never as simple as they look and seem by appearance. Exploring emotions and stories of trial and triumph can help children bring meaning and understanding to the relationship they have with symbolic fictional characters or (in the case of telling stories from your family and friends' past) the real people they love.
And that, to me, is what bedtime tales are all about.