DataCogs Solution Page:
http://datacogs.com/datablogs/archive/2007/08/26/641.aspx
This was further enhanced by Patrick Tisseghem to allow a grandchild dropdown. Visit Patrick's Page at:
http://blog.12thwave.com/?p=7
Expanding on Patrick's modified version to allow a grandchild dropdown list, I've added the functionality to filter the items in the dropdown.
Also, the "Required Field" validation was not validated accurately and this has been taken care of in my modified source.
Below find a few screenshots of configuring and using the custom field -
I have a list called 'Continents':

A second list 'Countries':

And a third list 'Cities':

In my fourth list 'My Location' in which I would want to have the three dropdowns displayed, I create three columns : Continent, Country and City using my custom field 'Cascading Drop Down List (With Filter)'.

The three columns created are -

Configuring the columns and using the filter -



When adding a 'New Item' to the 'My Location' list, the first dropdown will have "Please select an Item' (which is also something I added) as the first item in the dropdown.
Cascading Drop Down List (With Filter) in action:

According to the filter set, the list of continents that appear are only the ones that contain 'America'.



Many thanks to Datacogs and Patrick for their valuable contribution to the SharePoint community.
For the solution file (.wsp) and complete source code, please visit the project page at:
http://cascddlistwithfilter.codeplex.com/
Please feel free to post your comments/suggestions.