Microsoft has shown off its "virtual human" that reacts to a person's emotions, body movements and voice.
Milo, as he is known, is designed for use with the firm's hands-free Xbox 360 motion controller called Kinect.
The technology is the brainchild of veteran UK games designer Peter Molyneux.
"I want to introduce a new revolution in storytelling," he told the TED (Technology, Entertainment and Design) Global conference in Oxford.
"Films, TV, even hallowed books, are just rubbish because they don't involve me," he said. "It's a sea of blandness."
Mr Molyneux said that he wanted to create a character "that seemed alive, that would look me in the eyes, and feel real".
Milo was first shown off in a demo at the E3 expo in 2009, but has not been seen since.
"There was a huge row online about that with people saying 'this can't be real'," Mr Molyneux said.
The live demonstration used Microsoft's soon-to-be released Kinect controller, which uses a series of sensors, cameras and microphones to interpret a player's intentions.
The demo was conducted by an assistant, who showed Milo exploring a garden, learning to skim stones and finally confiding in him after being told off by his parents.
"We're changing the mind of Milo constantly," he said.
"No two people's Milos can be the same - you are actually sculpting a human being. Some of the things you are doing will change the course of his life."
Mr Molyneux said Milo had been built using artificial intelligence developed by his firm Lionhead studios, along with technology that was "hidden in the dusty vaults of Microsoft".
He said the system exploited psychological techniques to make a person feel that Milo was real.
In addition, software allowed "complete control" over subtle facial elements such as blushing and even the diameter of Milo's nostrils, which he said could denote stress.
"Most of it is just a trick - but it is a trick that actually works," he said.
During the demonstration, the player egged Milo on to squash a snail in the garden.
Mr Molyneux said that commands such as these were interpreted by Milo using voice-recognition software along with a database that attempted to interpret the players intonation and meaning.
These seemingly inconsequential events could also impact on Milo's later life and development in the game, he said.
The demonstration showed the initial stages of the game, where players learn to interact with Milo.
"After three-quarters of a hour, he recognises you," said Mr Molyneux.
"I can promise you that if you are sitting in front of this screen, that is a truly wonderful moment."
He said that the later stages of the game, which were not shown, allowed a player to explore the landscape with Milo more freely.
"There are lots of adventures - some of which are quite dark," he said.
At the moment, the technology is still in development and Microsoft has no plans to release it, he said.
However, he hinted that the game was designed to be used for millions of people and therefore could one day become a commercial product.
"His mind is based in the cloud," he told the audience. "As millions of people use it, Milo will get smarter."
Mr Molyneux showed off the technology at TED Global (Technology, Entertainment and Design), the European version of an established US event.
The invitation-only conferences explore "ideas worth spreading" and have featured talks by the former UK prime minister Gordon Brown and Nobel laureates as well as lesser-known technologists and designers.
This theme of this year's event is, "and now the good news".
"Good news has become a near-extinct species," said Bruno Giussani, European director of TED at the opening of the conference.
"But if you dig deeper, there is new technology, new science, new art, new ways of collaborating that offer a more hopeful view of the future."
Invited speakers at this year's TED include a voting system designer, a women's rights activist, a green chef and a physicist who runs a lab that aims to allow anyone to make almost anything.
Each is given 18 minutes in front of the audience.
This year's conference runs from 13 to 16 July in Oxford, UK.