The doll that Lily carries around is representative of her innocence and perpetual state of childhood, one that, in a way that is simultaneously tragic and merciful, she will never leave behind. She has the doll with her wherever she goes, and it becomes an object of contention when considered by Barry and Jim, two degenerate and deplorable men who wish to see Lily as a woman and, therefore, as an object. When Barry and Jim make advances against Lily, she demonstrates a surprising degree of defensive instinct, and clutches her doll closely as if in an act of defiance. Interestingly, she is standing her ground as a child, refusing to fall into the adult world wherein the men could subjugate her.
After Old Woman Magoun makes the incredibly difficult decision to allow Lily to eat nightshade berries rather than to be sold off to a life of misery by her father, she mentions in passing that the "dolls are alive" when she is describing heaven to Lily. She is implying to Lily that there will be no threats like the kind that her father represent in the eternity thereafter, and she can remain an innocent child forever. Old Woman Magoun is clinging to this hope after Lily's death, and this is perhaps why she carries Lily's doll wherever she goes.