FULL PRODUCT VERSION :
java version "1.6.0_01"
Java(TM) SE Runtime Environment (build 1.6.0_01-b04)
Java HotSpot(TM) Server VM (build 1.6.0_01-b04, mixed mode)

ADDITIONAL OS VERSION INFORMATION :
Version 5.1.2600

A DESCRIPTION OF THE PROBLEM :
The xerces parser included in the JDK handles entity references incorrectly, if they include literal unicode characters with a codepoint value larger than 65536.

This bug surfaced when using the saxon XSLT transformer, therefore the bug has first been filed as a bug against saxon. However, the developer, Michael Kay reported that the bug lies in the underlying XML parser of the JDK, not in saxon. More information is available here:
http://sourceforge.net/forum/forum.php?thread_id=1670443&forum_id=94027
and
http://sourceforge.net/tracker/index.php?func=detail&aid=1660205&group_id=29872&atid=397618


STEPS TO FOLLOW TO REPRODUCE THE PROBLEM :
This uses saxon to produce the results:
File test.xml:
<?xml version="1.0" encoding="utf-8"?>
<!DOCTYPE div [
<!ELEMENT div ANY >
<!ENTITY test1 '?'>
<!ENTITY test2 '&#x2643D;'>
]>
<div>
    ??&test1;&test2;&#x85F4;?'?'
</div>


----
This is the file used for transformation:
test.xsl
<?xml version="1.0" encoding="utf-8"?>
<xsl:stylesheet xmlns:xsl="http://www.w3.org/1999/XSL/Transform" version="2.0">
    <xsl:output indent="yes" method="xml"
        omit-xml-declaration="no"/>
    
    <xsl:template match="*">
        <xsl:copy>
            <xsl:apply-templates select="@*"/>
            <xsl:apply-templates select="*|processing-instruction()|comment()|text()"/>
        </xsl:copy>
    </xsl:template>
</xsl:stylesheet>

EXPECTED VERSUS ACTUAL BEHAVIOR :
EXPECTED -
<?xml version="1.0" encoding="UTF-8"?>
<div>
    ??????'?'
</div>

ACTUAL -
<?xml version="1.0" encoding="UTF-8"?>
<div>
    ?????'?'
</div>


ERROR MESSAGES/STACK TRACES THAT OCCUR :
There is no error message, just a silent failing.

REPRODUCIBILITY :
This bug can be reproduced always.

CUSTOMER SUBMITTED WORKAROUND :
A workaround seems to be to use numeric character entities, in this case '&#x2643D;'?as in entity test2 above.