Spreadsheet Modeling and Decision Analysis, 3e, by Cliff Ragsdale. © 2001 South-Western/Thomson Learning. 8-1 Introduction to Nonlinear Programming (NLP) u An NLP problem has a nonlinear objective function and/or one or more nonlinear constraints. u NLP problems are formulated and implemented in virtually the same way as linear problems. u The mathematics involved in solving NLPs is quite different than for LPs. u Solver tends to mask this difference but it is important to understand the difficulties that may be encountered when solving NLPs.

Spreadsheet Modeling and Decision Analysis, 3e, by Cliff Ragsdale. © 2001 South-Western/Thomson Learning. 8-2 Possible Optimal Solutions to NLPs (not occurring at corner points) objective function level curve optimal solution Feasible Region linear objective, nonlinear constraints objective function level curve optimal solution Feasible Region nonlinear objective, nonlinear constraints objective function level curve optimal solution Feasible Region nonlinear objective, linear constraints objective function level curves optimal solution Feasible Region nonlinear objective, linear constraints

Spreadsheet Modeling and Decision Analysis, 3e, by Cliff Ragsdale. © 2001 South-Western/Thomson Learning. 8-3 Local vs. Global Optimal Solutions A C B Local optimal solution Feasible Region D E F G Local and global optimal solution X1X1 X2X2

Spreadsheet Modeling and Decision Analysis, 3e, by Cliff Ragsdale. © 2001 South-Western/Thomson Learning. 8-4 Comments About NLP Algorithms u It is not always best to move in the direction producing the fastest rate of improvement in the objective. u NLP algorithms can terminate a local optimal solutions. u The starting point influences the local optimal solution obtained.

Spreadsheet Modeling and Decision Analysis, 3e, by Cliff Ragsdale. © 2001 South-Western/Thomson Learning. 8-5 Comments About Starting Points u The null starting point should be avoided. u When possible, it is best to use starting values of approximately the same magnitude as the expected optimal values.

Spreadsheet Modeling and Decision Analysis, 3e, by Cliff Ragsdale. © 2001 South-Western/Thomson Learning. 8-6 The Portfolio Optimization Problem u A financial planner wants to create the least risky portfolio with at least a 12% expected return using the following stocks. Annual Return YearIBCNMCNBS 111.2%8.0%10.9% 210.8%9.2%22.0% 311.6%6.6%37.9% 4-1.6%18.5%-11.8% 5-4.1%7.4%12.9% 68.6%13.0%-7.5% 76.8%22.0%9.3% 811.9%14.0%48.7% 912.0%20.5%-1.9% 108.3%14.0%19.1% 116.0%19.0%-3.4% %9.0%43.0% Avg7.64%13.43%14.93% Covariance Matrix IBCNMCNBS IBC NMC NBS

Spreadsheet Modeling and Decision Analysis, 3e, by Cliff Ragsdale. © 2001 South-Western/Thomson Learning. 8-7 Defining the Decision Variables p 1 = proportion of funds invested in IBC p 2 = proportion of funds invested in NMC p 3 = proportion of funds invested in NBS

Spreadsheet Modeling and Decision Analysis, 3e, by Cliff Ragsdale. © 2001 South-Western/Thomson Learning. 8-8 Defining the Objective Minimize the portfolio variance (risk).

Spreadsheet Modeling and Decision Analysis, 3e, by Cliff Ragsdale. © 2001 South-Western/Thomson Learning. 8-9 Defining the Constraints u Expected return p p p 3 >= 0.12 u Proportions p 1 + p 2 + p 3 = 1 p 1, p 2, p 3 >= 0 p 1, p 2, p 3 <= 1

Spreadsheet Modeling and Decision Analysis, 3e, by Cliff Ragsdale. © 2001 South-Western/Thomson Learning Implementing the Model See file Fig8-26.xls