I rule that it still emanates light, starting, say, a foot away from the invisible character.

Chainsaw wrote:

Ok, cool. That's pretty much what we decided upon as well.

Two quick follow-ups:

Items grabbed after the spell has been cast do not become invisible when possessed, correct? Of course, if an item was small enough to be hidden in an already invisible item, then that would work - like stuffing a newly found gem into an invisible belt pouch.

What about if you lifted up your cloak, already invisible with you, in such a way as to hide something else?

I don't think either of those scenarios would work. If you have 10 gp in a pouch when you cast invisibility on yourself, the pouch and the 10 gp become invisible. If you pick up an 11th gold piece, it remains visible. Adding it to your invisible belt pouch shows the viewer a single gold piece floating in the air at waist height. Likewise with concealing a visible object with your invisible cloak: If you stand invisibly before a crown on a pedestal, I can see the crown through your invisible form; invisibility would be worthless otherwise. Why then would the crown disappear from sight if you folded it into your invisible cloak?

Chainsaw wrote:

Thinking about it more, I agree with you on both counts. If the cloak's not handled that way, where would the effect end and why? Why would it hide the crown, but not the wall behind the crown? Why not the earth behind the wall behind the crown? You would potentially get this infinite hiding - there would be like a "nothingness" behind the cloak. If you can't hide an item with the cloak, then you can't do it with the pouch either. Thanks!

I suppose you could argue that if an invisible creatures claims an object (coin, crown, whatever) as a personal possession, it becomes invisible as well.  The thin air, walls, and landscape behind the creature couldn't reasonably be claimed as personal possessions, so they would remain unaffected.  Nor would other creatures be affected if (for example) draped with an invisible cloak.

However, in fact I agree with you and Dave: only the things actually held or carried by a creature at the time the dweomer takes effect become invisible.  Anything picked up later remains visible and appears to float in the air.  Reason: this is more hilarious for the DM and inconvenient for the PCs.