After trying a variety of video formats and codecs, I have found that compressing to a 512kbs Windows Movie is pretty clear. I plan to keep experimenting until I am able to film a machinima video that highlights the educational potential of virtual reality.
(Years later, in 2020, I revisit this post and see how blurry my first machinima actually was! The memory of this experience with my daughter is as vivid and real as any physical experience. Capturing her walking across the bridge on ISTE Island was my first virtual video shot.)