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Nobody expects the Imperial Inquisition!
It happens but to my knowledge they stop being the Chapter Master. Being in a Dreadnought probably makes you unfit for command. And since Dreadnoughts don't fill a HQ slot, there's no way you can actually play one as the Chapter Master. You can say "Oh, here's my Dreadnought containing the previous Chapter Master," but you will need an actual HQ unit to fill your HQ slot for your FOC to be legal.
Good old Bjorn is a neat exception to this rule. He's exempted because his name is Bjorn.
The above poster = Totally a member of the Fluff Masters Clan. Click here for fluff pwnage.
Come, sons of LO! Kneel before Poodle!
Mr_Wayne: "Some people believe that the World Eaters do not field any ranged weaponry. Those people often die at a distance."
The Blood Swords Chapter (Blood Angels successor) has or had a Dreadnought as their chapter master, so it's not unprecedented.
“ Belief in a cruel God makes a cruel man. ” - Thomas Paine
Invictusvis has it right, although some will poo poo Black Library as not official enough, especially James Swallow's stuff. The current codex does mention Dreads sitting on the Chapter Council or what not....it does get tricky with the foggy Dread mentality though.
In the end, go with it if it makes you happy. On the table, as Poodle said, it's going to be tricky, but I'm sure you'll find a way to fudge it. Good luck!