As I understand it, there are three mechanisms.
-At low frequencies, the direction can be judged from the
phase difference between the signals at each ear.
-Below 1 kHz, the direction is judged by the difference
in arrival time.
(At 2-3 kHz, we judge poorly.)
-Above 4 kHz, we use the intensity difference.
Front/back and up/down discrimination are poor, but
the pinna help this.
A good starting source is "The Science of Sound" by Thomas
D. Rossing. There's also a few psychoacoustics links on my
<a href=http://capella.dur.ac.uk/doug/acoustics.html>acoustics page</a>.
Hope this helps,