This is one of those phenomena we nearly all will have experienced without necessarily realising it has a name.

The name in question is generally thought to have first been used by the American writer Sylvia Wright in 1954, when she recalled in an essay in Harper's Magazine that as a child she had misheard the phrase "Laid him on the Green" in a Scottish ballad as "Lady Mondegreen".

There are various interlinked explanations for the phenomenon. Of course, it may be a simple mishearing, or may also be a manifestation of cognitive dissonance with the brain striving to make sense of that half heard or misheard. Sometimes it is intentional and used for deliberate comic effect - examples of this being "All of the other Reindeer" turning into "Olive the other Reindeer" in Vivian Walsh's 1997 children's book of that name. To stay with matters Christmassy, sometimes what may originally have been a mondegreen can even metamorphose into the mainstream version of the lyric - the transformation of "Colly Birds" to "Calling Birds" in "The Twelve days of Christmas" being an example.

On occasion the title of a song itself, especially in translation, can be a mondegreen - an example of this being "La Vie en Rose" (Life in Pink) turned into "L'Avion Rose" (The Pink Aeroplane).

There is also an interesting variant known as the "Reverse Mondegreen" where nonsensical syllables are heard as actual words - a classic example being the song "Mairzy Dotes" or "Mares Eat Oats."

More Info: en.wikipedia.org