Step 1: Understanding the book.
``Palace of Illusions'' is a novel that retells the Mahabharata from Draupadi’s perspective. Step 2: Analyzing the options. (A) Arundhati Roy: Known for \textit{The God of Small Things}. (B) Jhumpa Lahiri: Known for \textit{Interpreter of Maladies}. (C) Chitra Banerjee Divakaruni: Correct — She authored ``Palace of Illusions''. (D) Anita Desai: Known for works like \textit{Clear Light of Day}. Step 3: Conclusion.
The book ``Palace of Illusions'' was written by Chitra Banerjee Divakaruni.