Yesterday, Sony demonstrated the PSP-PS3 connection with more details. At launch, the PSP will play media files stored on the PS3 when both share a local network. According to Phil Harrison, the company hopes to launch worldwide internet support -- so you can access files on a home PS3 from any WiFi connection -- in the beginning of 2007.
During the presentation, Sony connected the two devices through the PS3's "Remote Play" menu. Once networked, the PSP controlled the PS3 through its built-in screen; the PS3 interface had moved to the PSP. (Also of note, the two game systems and some Sony TV interfaces look similar; Sony seems to be standardizing navigation across these devices.)
With the PSP driving the PS3, media files like movie trailers, photos, and music stream to the portable instead of playing on a TV. The demo resumed a Casino Royale trailer that had been stopped earlier on the PS3.
Sony didn't demonstrate portable games, like PS1 titles, through this connection.
The PSP can't tune TV channels through the PS3, like Sony's LocationFree devices. Phil Harrison later told us that this was not a LocationFree implementation; the results are similar, but the connection differs. When the service moves to the internet in a few months, this may be the easiest way to watch media stored at home in other locations.
CES: PSP LocationFree TV details
PS1 catalogue on PS3 not yet playable