>Why do the people of the Isles have trouble Believing Sheogorath is a Daedra Prince?
Sheogorath appears to be mantled every now and then by a mortal. The mantling previous to the Hero of Kvatch was believed to be done by a mortal named Arden Sul.
In my own opinion I like to think that the lol so random Sheogorath we are shown is actually a delusional figure-head position given to mortals, and that the Shivering Isles are merely his make-believe-land where he is King. I like to think the true enigmatic Sheogorath makes his small presence known in the form of the much less theatrical Haskill, who sits back and pulls the strings of the Shivering Isles, and possibly many more realms.
Though the ESO devs would disagree with me on that.
>Where do the people come from? Are they all Sheo's followers transported from Tamriel, or are people born and raised on the Isles?
I'd imagine that they are intended to be dead mortals who either worshiped Sheogorath or were insane.
>What is up with the indigenous wildlife? (Scalons, Elytra, Grummites etc) Could they be considered Lesser Daedra?
I couldn't see them being anything else.
>Is there more to the realm, or is Sheogorath's entire realm one single island?
It is mentioned in the Daedra Lord Census that Sheogorath's realm is known as "the Asylums", so I imagine his realm is more than likely made up of a myriad of varying pocket realms, much like Sanguine's.
All and all, Shivering Isles DLC is pretty god awful when you consider how mind-numbingly simple and comprehensible the god and realm, from which all madness derives from, are. Hence the reason why I refuse to believe the DLC actually shows the real Sheogorath or the real Realm.