Translation necessarily has a creative component, as languages do not not map 1-1 to each other, and cultures all have their different ways of expressing things, let alone references to obscure things that audiences in another language have absolutely no hope of knowing about. But there are very much differences in attitudes towards how those challenges should be handled. I can't help but think of a little event in Persona 4 that really captures this for me (so much that I have this screenshot of it from forever ago).
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The correct answer, as per the game mechanics, is the first one (make up bullshit). Fundamentally, I disagree with this approach. When I run into this issue, what I'll do is grab the offending phrase and start doing web searches on it. Fortunately these days, there will often be encyclopedia entries about a lot of niche things, or you'll see people using it in actual conversations and be able to figure out what's going on. From there, you can decide if there is a sufficiently accurate English equivalent, or if not, how you want to represent it. Ancient weeb that I am, I find TL notes acceptable, so that may ultimately be the result.
In this way though I'm very happy to be doing fan TL rather than anything "professional". This way I can just handle it however I want to see it in the script: writing for an audience of one (me), rather than some theoretical audience of paying consumers. The "average player" experience can shove itself, I'mma just make the translation that makes me happy, and if there are others who enjoy it as well, then that's just a bonus.