There is some medieval Islamicate literature set in Europe. With the exception of a few travel narratives, though, it tends to be set in areas of Europe either ruled by Muslims—like Iberia (al-Andalus)—or adjacent to Muslim-ruled polities. Overwhelmingly prominent in the second category is the Byzantine Empire (Rūm, “Rome”), whose name came to represent Europe/”the West” for many medieval Muslim audiences.
Overall, however, Christian Europe was not well-known in the Islamicate world, and was not a popular setting for stories. While the Crusades valorized tales of expeditions to the exotic east among Europeans, the equivalent Islamicate topoi tended to bring their heroes to India, fanciful islands in the Indian Sea, Central Asia, and sometimes Eastern Africa or the Anatolian hinterlands. The Middle East was vitally important to European Christians as the site of the Old and New Testaments. For Muslims, by contrast, most of Europe was a peripheral backwater with little theological or other cultural interest.
However, regions of Europe ruled by Muslims were often significant areas of cultural production. Islamicate Iberia, often called al-Andalus, is the most prominent example. Between the arrival of North African armies in 711 CE and the destruction of the Emirate of Granada in 1492, significant portions of the Iberian peninsula were incorporated into various Muslim polities. Literature from al-Andalus includes several of the greatest writers of the medieval Arabic tradition—the polymath ibn Ḥazm (d. 1064), the poet ibn Zaydūn (d. 1071), and the mystic ibn ‘Arabī (d. 1240), to name just a few. While much of this literature is not straightforwardly narrative, much of it closely reflects its Andalusian context, and I think it would be fair to refer to much of it as “set in” Europe. A similar situation arose in Sicily (an Islamic emirate from 831-1091, with a significant Muslim community persisting into the 13th century), though I am less familiar with Siculo-Arabic literature other than the geographical treatise of al-Idrīsī (d. 1165). Karla Mallette’s The Kingdom of Sicily, 1100-1250: A Literary History would be a good place to look for more information.
But I realize these aren’t quite the kind of texts you’re asking about. Islamicate equivalents to texts like Parzifal—adventure narratives set in an exoticized Europe—are rarer for the reasons I outlined above, but some examples do come to mind. In the Persian Shāhnāma (“Book of Kings,” 1010 CE) of Abolqāsem Ferdowsi, the world is roughly divided into Iran, Rum (“Rome,” “the West,” “Byzantium”) and Chin (“China,” “the East,” “Central Asia”). The internal geography and cultural landscape of Rum and Chin are not clearly depicted, and Rum refers to Anatolia as often as it does to anywhere further west. But characters do voyage to these places with some frequency. King Garshāsp spends a significant portion of his youth as an adventurer-for-hire at the court of the Qaysar (Caesar) of Rum, fighting monsters and successfully wooing the Qaysar’s daughter Katāyun. Eskandar—Alexander the Great—is born in Rum, though his father is presented as the Persian King Dārāb. His conquests take him through Iran and India (historically accurate), as well as North Africa and al-Andalus (less historically accurate). The character of Candace of Meroë becomes, in Persian accounts, Qaydafa of Andalus. She recognizes the disguised Eskandar from his portrait, a story frequently illustrated in Shāhnāma manuscripts—here’s an example from the Harvard Art Museum .
As the paradigmatic Christian kingdom, Rum is used by some Muslim writers for didactic or allegorical purposes. A famous example is the tale of Shaykh San‘ān from Faridoddin ‘Attār’s Manteq ot-Tayr (“Conference of the Birds,” 1177). This tells of a pious religious leader from Mecca who dreams of praying to an idol in Rum, travels there and becomes infatuated with a Christian girl. She demands that he abandon his faith in elaborate, performative ways, and he complies, going so far as to become a swineherd. Eventually, he returns to his senses, his religion, and to Mecca; whereupon the girl follows him, converts to Islam, and dies. ‘Attār uses the story to discuss the nature of infatuation, love, and devotion; the Christianity it depicts is not an accurate version of the faith, but rather an “anti-Islam” incorporating Zoroastrian elements and outright fantasy alongside a few authentic aspects.
Very rarely, a writer will use a more specific location than the generic Rum. The only example that comes to mind is Vāmeq o ‘Azrā (“Lover and Virgin”) by ‘Onsori (d. 1039). This is a love story set on the Greek island of Samos, though it only survives in fragments. Its setting comes directly from its source, the late antique Greek romance Mētiokhos kai Parthenopē.
One other European location encountered in medieval Islamicate literature is the land of the Ṣaqāliba, or Slavs. This was understood to occupy areas north of the Caucasus mountains, which provided numerous slaves to the Mediterranean world (hence the etymological connection between “Slav” and “slave.”) While not as popular in literature as Rum, Ṣaqāliba does feature from time to time. Maybe the most famous example is in the “Red Dome” section of Nezāmi Ganjavi’s Haft Paykar (“Seven Portraits,” 1197), in which a Slavonic princess tells King Bahrām Gur a version of the story that would become famous, via various adaptations culminating in Puccini’s 1926 opera, as Turandot. While the name Turandot is Persian (Turān-dokht, “daughter of the steppe/Central Asia”), the version in Haft Paykar does not use this name, and is set among the Ṣaqāliba.
Finally, it’s worth mentioning accounts written by Islamicate travelers to European lands. Two of the most important in this context are the account of Aḥmad ibn Faḍlān (describing events in 921) and Ibrahīm ibn Ya‘qūb al-Ṭarṭūshī (describing events in 961-62). Ibn Faḍlān was part of a religious and diplomatic mission sent from Baghdad to the recently-converted King of the Volga Bulghars; al-Ṭarṭūshī was an Andalusian, probably Jewish or from a Jewish background, who traveled extensively through Europe, as far east as Prague and as far north as Hedeby. Their accounts are fragmentary—particularly al-Ṭarṭūshī’s, known only from quotations in other authors—but provide a fascinating “outsider’s view” on tenth-century Europe. Many approaches to these texts have stressed their value as positivist data on the customs of Europeans, particularly the pagan Norse traders whom both encountered. But I think it’s crucial to emphasize the literary and imaginative dimensions of these works, which—much like Marco Polo’s Devisement du Monde—contain clearly fictionalized elements. There aren’t snakes the size of trees along the Volga, for instance, and there’s no evidence that pre-Christian Norse people worshiped the star Sirius. Instead, these are tropes about exotic lands that the authors use to express their distance from the lived experience of their Islamicate audiences.
I hope this has been helpful! Please let me know if I can provide any clarifications, sources, or follow-ups. There may also be important examples I've missed--medieval Islamicate literature is a vast field, after all--so I'd welcome any additions to what I've presented here.