DOCBOOK: XML to XML and entities

I am doing an XML to XML transformation.

If I put the following into my XSL file, entities such as — create 
gibberish characters in the new XML file:

                 <xsl:output method="xml" />

If I replace the output method with "html" the entities work fine but the 
processing instructions no longer have the correct format.  For example - I 
get the following line without the ? for the closing tag:

                <?xml:stylesheet type="text/xsl" href="ae_toc.xsl">

I am using XT.

Any ideas?    Thanks very much, Freda