is it possible to create listview inside dialog?

this implementation doesn't require you to make any xml layouts. it was written as a case statement in "onCreateDialog" override, but you can adapt if for your purposes very easily:

AlertDialog.Builder builder = new AlertDialog.Builder(this);
builder.setTitle("Select Color Mode");

ListView modeList = new ListView(this);
String[] stringArray = new String[] { "Bright Mode", "Normal Mode" };
ArrayAdapter<String> modeAdapter = new ArrayAdapter<String>(this, android.R.layout.simple_list_item_1, android.R.id.text1, stringArray);
modeList.setAdapter(modeAdapter);

builder.setView(modeList);
final Dialog dialog = builder.create();

dialog.show();

because you are making a dialog with only a ListView, you set the onItemClickListener of the ListView, as there isn't one for the basic dialog class.

modeList.setOnItemClickListener(new AdapterView.OnItemClickListener() {
        @Override
        public void onItemClick(AdapterView<?> adapterView, View view, int i, long l) {
            switch(i) {
                case 0:
                    //do something for first selection
                    break;
                case 1:
                    //do something for second selection
                    break;
            }
            dialog.dismiss();
        }
    });

Yes.

You can always use a ListView inside a Dialog. And you definitely don't necessarily need ListActivity to create ListView.

Code may be something like this:

Dialog dlg = new Dialog(context);
LayoutInflater li = context.getSystemService(Context.LAYOUT_INFLATER_SERVICE);
View v = li.inflate(R.layout.my_layout, null, false);
dlg.setContentView(v);
dlg.show();

my_layout.xml:

<ScrollView xmlns:android="blah"
   android:id="xid"
   android:layout_height="h"
   android:layout_width="w">

  <ListView blah blah blah attributes
  />

 </ScrollView>

You don't really have to extend listActivity in order to use listviews.

Extending listActivity will give you some functionality for free, such as getListView() (if I recall the method name correctly), but that can just as well be done manually with findViewById() just as any other view.