If you want to use entity references such as & eacute; in XML, you have to declare them. You have a number of options: you can use numeric character references instead (for example & #xac;), or you can use the native character encoding of the character. Of course, you have to use the encoding you have declared in the XML declaration.
Michael Kay
http://www.saxonica.com/
Author, XSLT Programmer's Reference and XPath 2.0 Programmer's Reference