It's possible when using a computer in conjunction. Some people say 'What's the point when you can just emulate on the PC and use 2 players?'
For one, you each have your own screen (the PSP and the monitor). Second, the PSP is a great PS1 emulator in itself. And third, you don't have to have 2 people cramped on 1 computer. Well the third was is similar to the first but.. >_>
As a side note, 2-player Ad-Hoc with PSX games IS possible but I don't recommend it. This feature is very unstable and there will probably be lost connections. I have not tried it myself, but I've done my research.
You can also ditch the USB cable and use your WiFi for 2-player PSX buuut if you are using a Phat PSP nethost does not support pops over 4.01 which sucks because many, many PSX games work best on 5.00 pops. If you have a slim, go for it. Phat.. no.
Depending on the reaction to this video, I'd like to make a tutorial about setting up nethost too which allows you to play ISOs, eboots, listen to music, watch videos, and browse your pictures through any WiFi connection. There's a couple 'catches' to that though.. But the great thing is like with usbhost you can use your computer's massive hard drive to store these files and access on your PSP from the comfort of your couch. This would only be possible with usbhost if you had a hella long USB cable :P
I find nethost great for browsing pictures, watching videos, and listening to music. Playing ISOs and PSX games from it, however, have not worked well for me. But that just may be because of a poor WiFi connection I have. I've heard about a lot of people who can play games with nethost.
So I hope you find this useful. If not, let me know how I can improve it
