The Wife of Bath is quite explicit about setting her tale "in th'olde days of King Arthour" when "all was this land fulfild of fayerye" (863, 865). She makes a great point of separating the setting of the tale from the world of the pilgrims by telling how then, fairies walked everywhere, but now, the "limitaciouns" of friars "maketh that ther been no fayeryes" (878). Beyond getting in a subtle jab at friars (one of whom, remember, has just interrupted her Prologue), the Wife may be trying to emphasize that her tale is set in a world where different rules apply than the everyday ones with which the pilgrims are familiar.
It's not that the pilgrims would be unfamiliar with these rules completely, though. For, by setting her tale in Arthur's day in the time of fairies, the Wife signals to her audience that this is a lai or short romance. This leads them (and us) to expect knights, noble ladies, and supernatural incidents. It also leads us to expect certain behavior from specific characters. We expect the king to be a force for justice and order in the tale, and the knight to be honorable and (most importantly for our purposes) protect women. This last expectation is the one the Wife defies in order to 'hook' the audience. We're given a setting we recognize, but are immediately thrown off-kilter by behavior we don't expect. Thus, the setting in King Arthur's court in the time of the fairies does more than just signal that fairy tale conventions are coming; it also adds narrative interest to the tale by causing us to wonder how this dishonorable knight will transform into the kind of knight we recognize from these fairy tales.