I'm so sorry to hear about your loss. 
My mum does family-tree research stuff, and I remember her telling me that it used to be quite common in the days when infant mortality was high, for families to re-use first names even for younger siblings after a child had sadly died. So the historical precedent is good.
Is it a good idea though? Difficult one. It hinges around how your DD will feel about it, and that's impossible to know. It may make DD2 feel more connected to DD3, but in a good way or a morbid way, that's the question, and it's impossible to answer.
If it was DD3's middle name, I'd be more inclined to say just go for it. But as a first name, I must admit I do feel a little nervous about it - first names are even more about your identity as a person.
Will DD3 have a middle name? I you do go for it, it could help if DD3 has a middle name that's completely different, to reflect her own distinct identity.
Sorry, I am sitting on the fence a bit here!
It's not an easy one.
I would probably shy away from it personally, going for the middle name option to honor DD2 instead, because I would think of all sorts of reasons why not, questions it might raise in DD2's head about her identity. But then I am a worrier when it comes to these sorts of things. I read 8 baby names books and thought of a reason why not for all the names in them!
I hope my ramblings are helpful.