The problem may be a mixture of security settings and your web config.  My partner is running XP Professional with FAT on his notebook and never had any problems installing DNN as is without manually creating a database in SQL.

 I am running XP professional with NTFS and struggled to get DNN going. If I build the DNN site under My Documents or even in my Inetpub/wwwroot directory it refused to allow the database to be attached. Being lazy and looking for a shortcut I eventually found by creating a blank database directly in SQL Express with the SQL Server Management Studio express and then changing my web config sorted the installation problem out once and for all.

Just in case you want to make sure about your web config format for connecting directly to the blank SQL database here is an example where I have commented out the standard connection and changed it to a "manual" connection. . Remember that an error on the comments --> can really stuff you around badly.

<connectionStrings>
    <!-- Connection String for SQL Server 2005 Express
    <add
      name="SiteSqlServer"
      connectionString="Data Source=.\SQLExpress;Integrated Security=True;User Instance=True;AttachDBFilename=|DataDirectory|Database.mdf;"
      providerName="System.Data.SqlClient" />
    Connection String for SQL Server 2000/2005  -->
    <add name="SiteSqlServer" connectionString="Server=armandnotebook\sqlexpress;Database=dnn;uid=sa;pwd=nelavm;" providerName="System.Data.SqlClient" />
  </connectionStrings>
  <appSettings>
    <!-- Connection String for SQL Server 2005 Express - kept for backwards compatability - legacy modules 
    <add key="SiteSqlServer" value="Data Source=.\SQLExpress;Integrated Security=True;User Instance=True;AttachDBFilename=|DataDirectory|Database.mdf;"/>
    Connection String for SQL Server 2000/2005 - kept for backwards compatability - legacy modules -->
    <add key="SiteSqlServer" value="Server=armandnotebook\sqlexpress;Database=dnn;uid=sa;pwd=nelavm;" />