Artificial intelligence (AI) techniques and virtual reality (VR) make possible powerful interactive stories, and this paper focuses on examples of virtual characters in three dimensional (3-D) worlds. Waldern, a virtual reality game designer, has theorized about and implemented software design of virtual teammates and opponents that incorporate AI techniques including fuzzy logic, neutral nets, and genetic algorithms. He asserts that one of the primary goals of VR is to generate virtual actors with whom the participant can interact in a contextually meaningful fashion, and proposes a classification scheme for such characters, as determined by intelligence level and centrality to the game. Virtual characters that can reason about their environment in original ways are being developed. PLACEHOLDER, a VR art project inspired by Native American myths and stories, features virtual characters where VR explorers can play the role of a bird, snake, person, or other creature. Participants, embodied in "smart costumes," take on the animal's pattern of movement, character, physical abilities, and may explore different sites or mark home territory. Other examples of virtual characters are: Dolby's "Virtual String Quartet," which synchronizes animated figures with 3-D sound; and an "avatar," a virtual character that reflects a person's look, mood and personality, and who represents him or her in a virtual world. (Contains 8 references.) (MAS)