The paper presents a distributed video compression (DVC) system with improved rate-distortion performance that is much closer to the performance of H.263 interframe coding as compared to existing DCT-based DVC schemes. The system performance, in terms of compression rate and video quality, is affected by the difference between the source information and the generated side information at the decoder. To improve the accuracy of the side information, a modified three-dimensional recursive search block matching algorithm is proposed. The performance of the proposed DVC system is also investigated when the side information is estimated from lossy video frames that are compressed at different bit rates. Coding results and comparison with existing DVC schemes and with H.263 are presented to illustrate the performance of the proposed system.