Actually, it could be the same-sized screen but with no bezel left & right, and a smaller area at the top and bottom. Result: Same 'live' touch area, smaller overall device.
I can't speak for holding it without the bezel, but I have to imagine they've tested it to death. Especially after the whole 'antenna' flap.
If it feels OK in the hand, and has the same size display, I can see where a smaller device could be popular.
But the current rumors about this are reporting that it would be "half the size of the iPhone 4". That's just too small to not have its own redesigned OS/user interface.